Runaway inflation raises doubts over Bank's power to rescue the economy

Andrew Bailey risks collision with Downing Street as recovery is nowhere in sight

Bank of England Governor Andrew Bailey
Governor Andrew Bailey on Thursday defended the Bank saying no one could predict the war in Ukraine a year ago Credit: ANDY RAIN/EPA-EFE/Shutterstock

For a man who's argued that we should look at the economy with a "glass half full mindset", Andrew Bailey presented a decidedly downbeat message as he told Britons they faced two years of financial pain.

The Governor of the Bank of England delivered its gloomiest forecasts since the pandemic, with none of the bounceback it predicted two years ago. A recession is coming: prices in the shops will keep on rising just as money in people’s pockets is being eroded by inflation. Meanwhile, pay won't keep up with price rises and close to a million more people will be out of work by the start of the next parliament.

But that may not be the worst of it. Despite the focus on the unprecedented income squeeze facing British families, the bigger problem is a lack of green shoots on the horizon. 

The economic contraction currently facing the UK is expected to be about as long and as deep as the decline of the 1990s, in the wake of the Lawson Boom, but a recovery is nowhere in sight. Britain’s economy in 2025 is still expected to be smaller than it was before the pandemic hit in 2019.

Bailey reiterated that it was his "absolute priority" to get inflation – which is expected to peak at 13.3pc – back under control. He cautioned the path to normality would be painful and, as the Bank upped interest rates, warned the alternative is "even worse".

Bailey said: "It will get worse precisely I'm afraid for those who are the least well-off in society. So while I have huge sympathy and huge understanding for those who are struggling most with this [...] I'm afraid my answer to [calls to stop raising interest rates], is the alternative is even worse in terms of persistent inflation."

Critics say Threadneedle Street was asleep at the wheel for far too long. Had it started raising interest rates earlier, it would not need to bring down inflation from a rate that is now more than five times its official target of 2pc.

"I don't know anyone who reasonably could say they could have forecast a Ukrainian war a year ago," said Bailey, in the Bank's defence.

While high energy prices are behind the surge in overall price rises, Gerard Lyons, chief economic strategist at Netwealth, argues the Bank played its part. 

"This inflation shock reflects external factors and poor monetary policy decisions last year," says Lyons, adding that "two wrongs don't make a right". 

"The first 'wrong' was that it didn't raise interest rates when it had the opportunity to and the economy could withstand it. But the second 'wrong' would be to try to correct that now by aggressively tightening,” says Lyons, who was also Prime Minister Boris Johnson’s former economic adviser.

"A better way is to now use steady rate rises to curb inflation and cut taxes and raise spending to address the lack of demand."

Much like Liz Truss, the frontrunner to become Britain’s next PM, Lyons believes that reversing a planned rise in corporation tax and the recent increase in National Insurance contributions would help the economic situation: "The last thing we need now is plummeting business confidence and a tax on jobs."

Urging policymakers to be more upbeat about growth prospects, Lyons says: "It was a very dismal message delivered. 

"In sharp contrast, the US Federal Reserve, which is dealing with a very similar economic outlook but was more reassuring that we will be able to come out of this."

Others, however, argue that solving Britain's current problem goes beyond the interest rate debate. 

Tory peer Lord Wolfson, chief executive of high street giant Next, says the Bank should continue to raise interest rates, but urges policymakers to encourage more economic dynamism

"It appears to me that it isn't that there's too much demand for the same number of goods, it's that actually there is a supply-side problem – a shortage of goods and services skills. And that's what's driving up prices,” he says. "Just printing money isn't going to actually increase the amount of goods in the country."

Wolfson insists that supporting the economy in the long-term, as the UK heads for recession, will require bold reform. 

“The most powerful thing, if you look at the nature of the challenges that the UK economy faces, at the moment, they are all on the supply side. It is about the amount of goods, the amount of oil, the energy generation, the amount of skill and labour available in the economy,” he says.

“Anything that can be done to improve the supply side, everything from speeding up planning, to release the land that's needed for housing development, through to more carefully thought through policy on allowing skills that the country desperately needs to flow in from overseas – it's going to be the supply side measures that really make a difference."

Britain's biggest business lobby groups agree more needs to be done to reinvigorate growth. 

David Bharier, head of research at the British Chambers of Commerce, says: “There are many causes of the current inflation crisis – global supply chain problems, trade barriers, soaring energy costs, increased taxes, and labour market shortages. Interest rate rises alone will do little to address these.

“Worryingly, our research indicates strongly that most small businesses are not investing for growth, and that longer-term confidence is beginning to wane.”

With a fresh cabinet likely to be formed under the incoming PM, Lyons says whoever is the next chancellor should set out his or her plans as soon as possible: "The challenge of course is you can't do everything at the same time. It's important to have a budget to see how it all fits together."

Of course, timing is everything – as are optics. Stefan Koopman at Rabobank highlights that politicians who say the Bank should act more forcefully to curb inflation now may live to regret it.

"Even though this seems a call for tougher action now, a deep recession in the years before the general election is unpopular too,” he says. "This will put the central bank on a collision course with Downing Street."

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