(Bloomberg) — Britain’s policy makers are hardening their attitude toward inflation, preparing to deliver a tough dose of medicine at a time when a cost-of-living crisis is weighing down growth and consumers.
Prime Minister Boris Johnson’s government along with the Bank of England this week signaled a readiness to raise interest rates at an unprecedented pace to rein in prices, which are on track to leap more than 11% this year.
Remarks from the Treasury and central bank indicate a switch of policy emphasis from supporting growth to preventing inflation seeping into wages and triggering a 1970s-style price spiral.
The moves follow the biggest increase in interest rates in the US since 1994 and calls for the BOE to step up its monetary tightening.
“The rhetoric was dialed up a notch, with the Bank saying it may have to act ‘forcefully’ should it be required,” said George Buckley, UK economist at Nomura Holdings Inc.
Johnson has been raising concerns about inflation for the last few weeks and took up the issue again on Monday, warning that the UK is headed for a difficult stretch.
“We’re seeing the effects of inflation around the world hitting this country as well as everywhere else,” the prime minister said at an event in Cornwall. “We’ve got an inflationary price bump that we’ve got to get through. “
On Tuesday, government data showed real wages falling at their fastest pace in two decades.
The BOE on Thursday raised its benchmark lending rate a quarter point to 1.25%, the highest since 2009, and suggested it may step up the pace of tightening at its next meeting in August.
BOE Chief Economist Huw Pill suggested Friday that further evidence of inflation driving up wages or shop prices could tip the bank toward a half-point rate hike. Investors bet the BOE will deliver several out-sized increases this year, bringing the key rate to 3 %.
Chancellor of the Exchequer Rishi Sunak made it clear he expects rate setters to get inflation expectations under control.
“I know and expect that you will take the action necessary to get inflation back on target and ensure inflation expectations remain firmly anchored,” Sunak wrote in his letter to the BOE.
The letter exchange is required after rate-setting meetings when inflation is more than 1 point off the 2% target. Inflation is currently 9%, and the BOE expects it to rise more.
The outlook for rates came in spite of data showing the economy shrank in the three months through June and signs that consumer confidence is crashing.
The scale of action that markets anticipate is unprecedented in the BOE’s modern history. The bank has never raised rates by more than a quarter point at a single meeting in its 25 years of independence.
There was a noticeably hawkish shift on the policymaking committee as a whole, with two members who had been hesitant about further rate rises now signed up for the “forceful” guidance. Pill told Bloomberg TV on Friday the old guidance was “a bit stale. “
He also reinforced the message that inflation expectations are paramount, saying: “If we see greater evidence that the current high level of inflation is becoming embedded in pricing behaviour by firms, in wage setting behaviour by firms and workers, then that will be the trigger for this more aggressive action.”
All the focus now appears to be on preventing inflation expectations losing their 2% anchor. Short term expectations are “close to their record high,” the BOE said on Thursday and “medium to longer-term expectations remained above their historic averages.”
Sunak’s letter was notably more matter-of-fact than previous exchanges, with a clear concern that inflation may become untethered.
“It is imperative to bring inflation back down to target and to keep it anchored there,” the chancellor wrote.
He also replaced the pleasantry, “I welcome the committee’s intention to take whatever action is necessary” with a more instructive, “I welcome that the Bank is prepared to take firm and decisive action to achieve this.”
The BOE is under pressure to move faster and harder, with several ruling Conservative Party MPs recently criticizing it for allowing prices to spiral upwards and many economists claiming it was too slow to respond.
Mel Stride, chairman of the cross-party Treasury Committee in the House of Commons, said that some of Bailey’s communications were “clumsy.”
Pill told Bloomberg TV that there was nothing the BOE can do about the immediate short term inflation pressures.
“We know is going to go higher due to energy price movements and other things which we can’t really contain shorter term,” he said.