BoE chief economist warns UK inflation set to hit 5%

Inflation in the UK is expected to rise “close to or even slightly above 5%” early next year, the Bank of England’s new chief economist has warned, saying the central bank will have a “live” decision on whether to raise interest rates. at its November meeting.

In his first interview in the role, Huw Pill declined to reveal how he would vote at the BoE’s Monetary Policy Committee meeting on November 4, saying that “it’s finely balanced,” but added: “I think November is live “.

Although consumer price inflation fell to 3.1% in September, the BoE previously predicted it would exceed 4% by the end of the year.

Inflation rose rapidly for much of 2021 due to the strong economic recovery from the coronavirus crisis, soaring energy prices and disruption of the global supply chain.

Pill’s view that inflation was likely to come back down in the second half of 2022 did not put him at ease with the sharp price hikes expected later this year and early 2022.

He said: “I wouldn’t be shocked – let’s put it that way – if we saw an impression of inflation near or above 5%. [in the months ahead]. And it’s a very uncomfortable place for a central bank with a 2% inflation target.

Financial markets are betting on the BoE’s interest rate hike as early as next month, spurred on by Governor Andrew Bailey’s comments over the weekend that the central bank “should act” to bring inflation under control.

But Pill advised traders not to worry too much about the exact timing of a rate hike, saying “maybe there’s a little too much excitement in the focus on rates right now” .

He urged the markets to look at the main underlying trends in the UK economy, saying they no longer need rates at the all-time low of 0.1%. “The big picture is, I think, there are reasons we don’t need the emergency parameters of politics that we saw after the pandemic intensified,” Pill said. .

“The settings [of monetary policy] that we have now are support settings. The need for support has diminished as this [policy] bridge [to the other side of the pandemic] was built and widely traversed.

Line chart of Bank Rate and Expectations (%) showing markets are now betting on a BoE interest rate hike in November

The role of the BoE’s chief economist – previously held by Andy Haldane – involves significant influence over interest rates, financial stability and the direction of research at the central bank.

Pill said the BoE’s action to stabilize the economy in the future should no longer be measured by the amount of quantitative easing it has effected, which would be “gradual and predictable” even if it involved cutting back. raise rates as the central bank still completes the last round of asset purchases until the end of 2021. The same would be true for asset sales in the future, he added.

“If you want excitement you should watch [interest] rate, ”Pill said.

While Pill has taken a hawkish stance on current monetary policy, he has been careful not to suggest that rates need to go much higher than the 0.75% level that existed before the Covid-19 pandemic.

“We do not see, given the transient nature of what we see in inflation in our baseline scenario, the need to go to a [policy] position, ”he said.

Pill said that since joining the BoE in September, there had been a “regime change” in monetary policy because the economy, based on the latest data available, had almost recovered to levels before the pandemic.

Line graph of UK monthly GDP (February 2020 = 100) showing UK output approaching pre-pandemic levels

After 13 years of focusing on stimulating household and business spending with ultra-low interest rates and numerous QE cycles, the BoE is now shifting its political focus to focus as much on containing the inflation, he added.

In the years following the financial crisis, Pill said that “monetary policy was boring because directionally it was pretty obvious what you needed to do,” and the only question was how much stimulus to provide.

That has changed, he added. “We have entered a different phase. Because there are risks on both sides [from inflationary pressures being too high or too low], the direction of monetary policy at any given time is less clear and this will lead, I think, to more controversy and more potential for disagreement within the [MPC]. But it is a sign of success because we have come out of the regime where monetary policy was boring.

Speaking about his motivation as the BoE’s chief economist, having worked early in his career at the central bank before moving to the European Central Bank, Goldman Sachs and Harvard University, he said he wanted ensure that UK households are not hit by high inflation.

While dismissing comparisons to 1970s inflation, he was clear about his main motivation for the BoE job.

“I’ve looked at this institution from the outside and I’ve always been pretty convinced it’s in the area of ​​price stability,” Pill said. “I entered and, as is the nature of entering institutions, you are surprised by some things while others confirm what you expected. One thing that is totally confirmed is that [the BoE] is an institution that works in the field of price stability.

Having had Otmar Issing, the ECB’s first chief economist, as a mentor and gently saying that the German should be called ‘Professor Issing’, many people will see Pill as a European inflation hawk who has landed in the inside the BoE.

Pill insisted that Issing’s reputation as a hawk was simply due to the shock of demand for German reunification in the 1990s and the supply issues – similar to today’s issues – that have made life difficult for a central banker.

“If I could bring a tenth of what he contributed to the Bundesbank and European monetary policy in extremely difficult times to what I do in my tenure here I would get out of this building, maybe not popular with of all the people in that building or all of the people outside, but I’d be pretty proud of that, ”Pill said.

He added that one of Issing’s great strengths was to introduce formal ECB systems to allow his staff to challenge dominant views: something he wants to foster more deeply at the BoE.

It would help the central bank to tackle group thinking with a more diverse staff. Pill said he recognizes he is not a diversity employee for the BoE, but added: “This is who I am.”

“I think I bring diversity to other dimensions,” he said. “I’m not sure there are many other MPC members who would like to be identified as Otmar Issing’s sidekick when I’m quite proud to be identified like that.”

One of the policies Pill wants to abandon to the BoE is the much-praised interest rate forecasting of former Gov. Mark Carney, who has vowed not to toughen the policy until certain conditions are met.

Pill said such guidelines always start “well enough” with good intentions, but “always end with some confusion.”

Glad the BoE abolished its most recent guidance, Pill believes the economy has weathered the pandemic well so far, with fiscal and monetary policy helping households and businesses almost on the other side of the crisis. .

While acknowledging the risks of a resurgence of the coronavirus, he said there was little reason to change the BoE’s view that the long-term economic blow from the pandemic would be of little more than 1% of gross domestic product, with scars considerably shallower than the UK’s budget watchdog is expected to forecast next week in Chancellor Rishi Sunak’s budget.

The emerging evidence of the impact of the end of the government leave scheme for workers in companies is positive, he added, because “we do not expect a big increase in the unemployment rate”.

But in a “fairly tight labor market,” he has not currently seen wage increases that threatened to spark a second round of inflationary concerns.

Pill said he was “paid to worry about inflation” and that this would keep him in line with the interests of households and businesses, even though he has worked his career in the rarefied world. elite central banks, financial institutions and universities.

“Working at Goldman Sachs has been positive for me,” he added. “Working at the ECB has been positive. Working with Otmar Issing has been positive. Work at the BoE. . . it was very positive. Teach a lot of very smart people [in Harvard] was also extremely positive. I am therefore the product of my experience. I can’t deny my experience and we’ll see if I’m doing a good job or a bad job.

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