Sunday, June 18, 2023
The Bank and its governor have run out of excuses
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

It was not supposed to be like this. Had things gone according to plan, the Bank of England could have sent people off on their holidays, if not with a song in their hearts, at least with a reassurance that the worst was over. The Federal Reserve, America’s central bank, paused its rate-rising on Wednesday, though maybe not for long, to give time to assess the impact of its rate rises so far.

For the Bank, though, it is not looking good. Even good inflation figures this week will not calm nerves. As it is, after three disappointing inflation releases in a row, not forgetting the many months of double-figure inflation that preceded them, gloom has set in.

Salvation may not come from Junction 28 of the M4 in Newport, where the Office for National Statistics (ONS) resides. Indeed, the ONS, with its latest figures on wages, showing annual regular pay growth in the January-April period running at 7.2 per cent, and 7.6 per cent in the private sector – the highest in normal times since 2001 – showed the Bank in a very deep hole.

This is not so much a wage-price spiral, pay driving inflation higher, one element of the British disease of the 1960s and 1970s, but a price-wage spiral. Wages have responded to the Bank’s loss of control of inflation. It would appear to have left itself no option but to continue doing what it has been doing, raising interest rates, until something breaks. And, to repeat, doing the same thing repeatedly and hoping for a different result is one definition of madness.

Given a tight labour market with employment still growing and the unemployment rate at just 3.8 per cent, it is anybody’s guess how much rates might need to rise to get wage growth down. Andrew Bailey, the Bank’s governor, admitted recently its model was not working and that it has “very big lessons to learn” over its forecasting failures. Those lessons will be the subject of an external review of its forecasting model, conceded by the Bank’s Court after pressure from the Commons Treasury committee.

I have to feel a tinge of sympathy for Rishi Sunak and Jeremy Hunt in this. After steadying the ship after the Liz Truss madness (ignore the nonsense about her being right all along) and put their faith in the Bank to get inflation down, they now find themselves on the wrong side of a mortgage crisis.

So far, I have mainly given Bailey and the Bank the benefit of the doubt. He took over at a difficult time, on the eve of the first pandemic lockdown in March 2020 and, while it soon became clear that there would be a post-pandemic inflation problem, raising rates when the economy was only emerging blearily from lockdowns would have brought a ton of criticism down on Threadneedle Street, though it is getting that now. It could not have known Russia would invade Ukraine.

But it is time for me to take the gloves off. The Bank’s ongoing failure to control inflation not only sets us apart from every other major economy but has damaging consequences for society as well as the economy. People who had no inkling two years ago that mortgage rates might reach more than 5 per cent and were encouraged by the Bank’s language on temporary or “transitory” inflation in that view, now face a devastating hit.

The Bank’s failings have brought back another element of that old British disease, strikes. Everybody has faced, and continues to face, a severe cost-of-living crisis, hence pressure for higher wages. Firms are still responding to inflation rather than growing their businesses.

The Bailey Bank has failed on three fronts. Its response to the pandemic was badly flawed. Crises differ in nature. Large amounts of quantitative easing (QE) were the right response to the financial crisis, when the banking sector was badly damaged, and did not cause an inflation problem.

Large scale QE in 2020, in response to the pandemic, was a mistake. It looked then, and look now, like a way to make it easier for the government to fund the huge pandemic spending it was embarking on without crashing the gilt market. Even more inexplicable was continuing with it through to the end of 2021, long after inflation began rising strongly.

Andy Haldane, its former chief economist, left the Bank after raising the alarm on this, voting in June 2021 to reduce the eventual stock of QE by £50 billion, and should have been chained to his desk to stop him leaving. There was a time when the Bank, at senior level, consisted of hard-bitten and experienced central bankers, sound money obsessives. Now it is dominated by Treasury and Goldman Sachs alumni, working alongside a governor who, even after three years, is quite new at the job.

Bailey did not initiate the Bank’s communication problem with the markets and business. That started with his predecessor Mark Carney’s forward guidance. But the current governor has compounded it. Once it took a mere raising of the governor’s eyebrows for people to take notice. Now, Bailey could stand on the roof of the Bank with a megaphone and might not get a response. The Bank relied too much on the low inflation expectations built up over a quarter of a century of independence.

Exhortations aimed at those bargaining pay not to chase inflation higher have clearly failed, while simultaneously heaping criticism on the Bank. When well-paid public officials urge wage restraint on others it does not look good.

With those failed interventions comes a loss of credibility. In its May monetary policy report – just last month – the Bank predicted that inflation would fall quickly to 5 per cent by the end of this year and 2 per cent, the official target, by the end of 2024, before dropping even further.

That was conditioned on the then market view that Bank rate would peak at 4.75 per cent (a market view that is now much higher), though the drop to 2 per cent would occur even without any further rise. A central bank with credibility would look at recent figures on prices and pay and say they do not change our longer-term view. They might concede a further quarter-point rise this week, not set off a debate about whether they need to do a half-point. Market talk of rates rising to 6 per cent would never have arisen.

Instead of which, the Bank is blown about in the wind, unable to explain why inflation has been so sticky and “core” inflation so high, and unable to explain why the growth in wages is so strong. Central banks are supposed to lead markets, not follow them.

For the Bank, winning back credibility after this episode, with the public as well as with markets and business, will be a struggle. Talk of handing back control of interest rates to politicians, which would give the UK an even bigger credibility problem, is growing louder. Downing Street was even flirting with the idea of voluntary price controls on food. Strange ideas threaten to fill the vacuum left by the Bank’s loss of credibility.

The Bank desperately needs some good news soon. It and its governor have run out of excuses.