Huw Pill, the Bank of England’s chief economist, said on Friday it was “crucial” to prevent the UK from drifting deeper into “inflationary psychology”, indicating he favored further rate hikes.
With inflation hitting a 40-year high in April, Pill said prices, which had risen more than four times the central bank’s 2 percent target, were “obviously leading to a very uncomfortable situation” and promised to lower inflation.
But he added that the BoE was still grappling with the difficult question of how much inflation alone would fall as household finances were being hit hard by the cost of living crisis.
Among the key factors determining how much interest rates need to rise, Pill said, is whether companies feel they can raise prices without much consequence and whether people feel they can demand higher wages without fear have to lose their jobs.
“The UK labor market is tight, wages are rising more than would normally be consistent with inflation targeting and business confidence is resilient, partly in anticipation of restoring profit margins. In short, inflation dynamics in the UK are strong right now,” Pill said.
He added that these dynamics were compounded behind rapid price increases by Brexit, which reduced the labor supply, a slowdown in globalization and the ongoing impact of Covid-19, which saw nearly 500,000 people exit the UK labor market.
“It is critical to avoid any tendency to embed such ‘inflation psychology’ in the pricing process,” said Pill.
Stronger-than-expected April retail sales figures could also increase pressure on the bank to hike interest rates, although details of the data suggest this may have been a one-off.
Pill predicted that more rate hikes would be needed in addition to the four already in place. This would raise interest rates from the current 1 percent level and help lower inflation by reducing spending.
“It is the need for this transition in monetary policy to continue that has led me to support the 25 basis point hike in interest rates at the MPC meeting in May,” Pill said. “And even after this hike, I still consider this necessary transition incomplete. It has to be worked on.”
Allan Monks, an economist at JPMorgan, said Pill’s clear concerns about inflation suggested a majority in the MPC was now “leaning towards a more restrictive interpretation” of the bank’s latest guidance. Monks added, “The risk of the MPC having to increase every meeting this year seems greater than being put on hold after August.”
Not considered one of the most aggressive members of the Monetary Policy Committee, Pill voted in favor of a quarter-point rate hike this month, in contrast to three of the nine members who favored a half-point hike.
He attributed his caution to the impending “substantial fall in the real incomes of UK residents, which will weigh on future demand and employment”.
But while Pill said he didn’t want quick rate hikes, he was clear that more hikes were needed to ensure high inflation in the UK wasn’t seen as normal.
“It is this commitment that has led me to support monetary tightening since I joined the committee last September and to signal today that that tightening needs to go further,” he said.
In one of the latest indicators of the current state of the economy, Friday’s retail numbers showed that UK sales rose 1.4 percent between March and April. This compares to declines in the previous two months and economists’ expectations of a 0.2 percent decline.
However, the retail data included an increase in supermarket sales of alcohol – a possible indication that the overall increase was partly due to consumers reacting to rising prices by staying at home rather than eating and drinking.