Why the Bank of England’s doom mongers are a thorn in Rishi Sunak’s side

Rishi Sunak sought to pitch Britain to investment heavyweights such as JPMorgan’s Jamie Dimon and Goldman Sachs’ David Solomon at Hampton Court Palace this week at the Prime Minister’s flagship investment summit.

Yet it was another man who inadvertently stole the show: Andrew Bailey.

While the prime minister painted an optimistic picture of Britain, he was overshadowed by the Bank of England Governor’s far more downbeat view of the economy.

The Bank chief told a local Newcastle publication that Britain’s growth potential was the worst he’d seen in his lifetime – a far cry from the image Sunak was trying to project. 

The Governor later admitted during a lunch at the event where he was seated on the same table as City Minister Bim Afolami that his comments did little to help Sunak’s pitch to businesses. 

But, Bailey was heard questioning, why should he not draw attention to the UK’s dismal record of improving productivity, given how poor it is?

It is the latest example of the growing tensions between two of the country’s most powerful institutions.

With growth undeniably in the doldrums, Sunak’s government is trying to drum up investment to improve the outlook and sell themselves to voters ahead of an election next year.

Yet at the Bank of England, Bailey and his colleagues are keen to talk down the economy as they battle to control inflation.

With optimism about potential rate cuts running high in financial markets, policymakers are keen to talk up the prospect of interest rates staying painfully high for longer and tamp down inflation-driving spending.

Deputy Governor Sir Dave Ramsden warned on Tuesday that price pressures are “becoming much more homegrown” and will force interest rates to stay high for longer. 

Jonathan Haskel, another member of the Monetary Policy Committee, also warned on Tuesday that lacklustre improvements in productivity and workers playing “catch up” with wage increases risked pushing up inflation.

“We now see ourselves in a situation where the central bank is trying to slow the economy and bring inflation down and the Government is trying to boost growth,” says Jack Meaning, chief UK economist at Barclays and a former Bank of England economist. 

“That means that the two are working in opposite directions.”

The growing division spells trouble for Sunak who is gearing up for a difficult election against the backdrop of a stagnating economy, the highest tax burden since the 1940s and persistent inflation.

The Government is keen to talk up the potential for all this to change. When Chancellor Jeremy Hunt last week delivered what will probably be his last Autumn Statement before an election, he said Britain was a “country that has turned a corner”.

Inflation has halved since the start of the year to 4.6pc and the economy has so far dodged a much-anticipated recession. Meanwhile, wages have finally started outpacing price rises.

The Chancellor’s rabbit-out-of-the-hat was a 2 percentage point cut to National Insurance, while low paid workers were also handed a boost with news that the National Living Wage will rise from  £10.42 to £11.44 an hour in April 2024.

Hunt’s Autumn Statement helped deliver a 4-point boost to the Conservative Party’s poll ratings according to YouGov, although it is still trailing 19 points behind Labour.

Conservative polling numbers are of little interest to officials at Threadneedle Street, who are far more concerned about inflation.

Worried that investors and businesses are getting ahead of themselves with hopes of rate cuts in the new year, policymakers have been keen to stress the economic risks that remain.

Sir Dave said on Tuesday that inflation in Britain’s services sector, which covers everything from lawyers to waitressing, was proving “much stickier” than hoped and was making it difficult to hit the Bank’s 2pc target for price rises across the economy. 

“We think that inflation is going to be really challenging to squeeze out of the system,” Sir Dave told Bloomberg TV.  “It’s driven by wages, where wage growth remains above 7pc.”

He is just the latest rate-setter seeking to quell market speculation of rate cuts next summer, with Bailey repeatedly saying it is “too early” to talk of lower borrowing costs.

Hunt’s Autumn Statement tax cuts and giveaways, particularly the National Living Wage boost, will only compound Bailey’s inflation headache, says Meaning.

“It will provide a boost to the wage growth numbers at almost exactly the time we expect the Bank of England to be thinking about whether wage growth is slow enough for them to start cutting rates,” he says. “So it will be this kind of one-off distorting factor at a really crucial time.”

Hunt’s giveaways fuelled speculation of a spring election, which would most likely coincide with local and mayoral polls in May.

Yet any mood boost from chunkier wage packets risk being undercut by still-high borrowing costs. Hunt’s giveaways have pushed back the prospect of rate cuts, economists say. In fact, interest rates may even have to rise even further.

“If there’s any country that is vulnerable to further surprise rate increases from here, it is probably in the UK,” says Shamik Dhar, BNY Mellon investment management’s chief economist.  

More interest rate rises would be a significant blow to Hunt and Sunak’s efforts to boost workers’ incomes: any gains from tax cuts can swiftly be wiped out by higher borrowing costs.

Dhar says that the announcements in the Autumn Statement were akin to “taking the foot off the brake” in the fight against inflation – not as bad as putting the foot on the accelerator, but not helpful either.

However, he agrees with Bank officials that taming wage pressures in the UK will be tougher than elsewhere.

“The UK is uniquely the country that is describing what we have been through as a cost of living crisis. Everywhere else they seem to be talking about higher inflation. 

“When you talk about things that dramatically, it embeds itself into inflation expectations and wage bargaining. That equally means it will be harder to get down and back to target.”

The tension between the Bank’s inflation target and the Chancellor’s desire to inject some feel-good factor into the economy underlines the bind Hunt and Sunak are in: the Prime Minister and his Chancellor must weigh up whether voters will be more compelled by falling interest rates or by being able to keep more of their paycheck through tax cuts. 

Yet with the Bank still concerned about inflation, neither are necessarily within their gift. 

As the fight against inflation enters its toughest final stage and an election draws near, the Bank’s downcast pronouncements have become a thorn in the Government’s side.