Bank of England's Caution Against 'Agressive' Interest Rate Rises

The Bank of England’s chief economist, Huw Pill, has warned that the UK’s monetary policy needs to be cautious against ‘aggressive’ rate rises.

Pill has advocated that a gradual rate rise was a better option, rather than a more aggressive monetary policy, looking to reduce aggregate demand in the economy. He also admitted that UK firms and households are inevitably going to have to have a squeeze of their income in the coming year, as the cost of living crisis continues.

Last week, the Bank’s governor, Andrew Bailey stated that real wages will have to fall this year in order to keep control of inflation. Although this came under sharp criticism from a range of different people, from politicians to union leaders, Pill backed Bailey’s message again on Wednesday. He added that the Bank’s monetary policy will be decided by the reaction and approach that UK households and firms would take when it comes to higher prices for imported energy and goods, as these are external factors that can not be controlled. He also continued saying: “The longer that firms try to maintain real profit margins and employees try to maintain real wages, the more likely it is that domestically generated inflation will achieve its own self-sustaining momentum.” This is referring to cost-push inflation, where an external factor creating a rise in the costs of production leads to producers passing on the costs to consumers, initially causing some level of inflation, and then as workers look to keep their real incomes constant, they demand a raise in wages. This once again leads to higher costs of production and so as firms and households try to keep their real profit and incomes constant, a spiral is created leading to continuous inflation.

The rate of wage increases currently is at 5 per cent for this year, as forecasted by the Bank of England. Pill believed that if the rate started to ease down by the start of next year, the UK economy’s inflation would be able to subside without leading to a recession. This was another concern of having too aggressive contractionary measures, as it was feared that it could lead to negative economic growth if demand was manipulated too severely using interest rate rises.

Pill also said how the markets were overestimating the Bank of England’s tightening of monetary policy in the coming year.

Keeping the interest rates at 0.5% indefinitely would leave it above target in the medium term, but raising them as sharply as market pricing implied (1.2% by December 2022) would take inflation below the target.

Pill also outlined that the Bank’s decisions were not fixed and would be more reflective of how different factors will play out. Lower energy prices may lead to the bank not raising rates a lot. However, he went on to say if households and firms acted by looking to maintain their real wages and profits, then they would need to have a more contractionary policy.

Surveys have shown that intense pressure on wage increases is evident. KPMG has said that there is a near-record rate of starting wage increases for new hires. Also, the British Chambers of Commerce said three-quarters of firms planned to increase prices in response to rising costs.

Rises in interest rates have been worsening the cost of living crisis as households now have less disposable incomes. The increase in the Bank rate to 0.5% means a typical tracker mortgage customer's monthly repayment will go up by £25.76. The typical SVR customer is likely to pay £15.96 more a month, UK Finance figures show.


Written by Florian Mihindukulasuriya Thiserage

Researched by Hugo Denage


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