Markets are underestimating how persistent inflation will be in the next year and interest rates are likely to remain high as a result, the governor of the Bank of England has said.
Mr Bailey told the Treasury select committee that despite inflation having passed the government’s target of halving this year, domestic “second-round” impacts mean the “last mile will be the hardest” as the Bank focuses on its mandate to return inflation to the 2% target.
“I really think the market is putting too much weight on the current data releases and the fact that we’ve seen inflation come down quite rapidly, that’s good news obviously,” he said.
“We are concerned about the potential persistence of inflation as we go through the remainder of the journey down to 2% and I think the market is underestimating that.”
The governor said last week’s abrupt fall from 6.8% was the result of elevated energy prices falling out of the annual inflation calculation, but there were no more large “base effects” left to drop out of the figures.
“It [the fall] was obviously good news – it was largely news that we expected,” he said.
“As we set out in the Monetary Policy Report, we expect a little bit more of what I would call this unwinding of last year’s external shocks to come through. We’re not going to get another one like last week though; that’s the last of those base effects to come through.”
Speaking 24 hours ahead of the chancellor’s autumn statement, Mr Bailey refused to be drawn on whether Prime Minister Rishi Sunak had played any role in cutting inflation from January’s peak of more than 11%, or whether tax rises of any kind could be considered inflationary.
The Bank’s most recent forecast is that inflation will fall to 3% next year and return to the 2% target in 2025.
Mr Bailey said food price inflation should fall further by the end of the first quarter of next year, but that consumers were still feeling the impact of the Ukraine war in weekly grocery shopping.
He said anxiety about the cost and availability of key inputs like fertiliser meant farmers had “locked in higher prices” by agreeing higher prices on long-term supply deals that were yet to fall away.
Deputy governor Dave Ramsden told MPs constraints on the supply side of the economy were effectively a “speed limit” on growth despite quite resilient demand.
Wage inflation, currently above 7%, was a key factor particularly in the services sector, which accounts for close to half of inflation, and where pay accounts for 60% of costs.
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He also pointed to the relative lack of business investment in the UK economy since the Brexit referendum in the summer of 2016.
“Business investment is 6% higher than in the second quarter of 2016, before the Brexit referendum, that’s an average of less than 1% a year. In that time US business investment has gone up 25%.”
In spiky exchanges with MP’s Mr Bailey also denied the central bank had been “behind the curve” in addressing inflation.
“We were the first major central bank to raise rates, so that is not true,” he said.