Andrew Bailey, governor of the Bank of England, shocked almost everybody in November when he kept rates at their current levels.
He now has the market in error by moving the borrowing cost up, when it was expected that there would not be any move before February.
In order to better understand the economic implications of Omicron, it was expected that the Monetary Policy Committee would continue its work.
Andrew Bailey (pictured, Bank of England governor) has misjudged the markets once again by raising borrowing prices when consensus was that there wouldn’t be any move until February
It is an indication of the Bank’s concern over inflation and its potential embedding.
It is a statement that Bailey and his colleagues on the Monetary Policy Committee – with the exception of sole dissenter Silvana Tenreyro – believe inflation is more dangerous to the economy than Omicron.
This week’s figure was significantly higher than expected. Peak Consumer Price Inflation is forecast to be at 6 per cent in April 2022, up from the 5 per cent forecast in last month’s Monetary Policy Report.
This alarming number, along with the ticking of the International Monetary Fund’s week, will have an impact on the Bank.
Bailey might have been reluctant as he was not looking to be the first central bankster out of the blocks. He does have some protection from the US Fed. Officials indicated that they plan to increase interest rates by three times next year in order to control inflation.
Although the inflation targeting regime at The Old Lady has been in effect since the 1990s, it is now facing its biggest test.
We are a long way indeed from former governor Mervyn King’s ‘nice’ decade, the non-inflationary, consistently expansionary era from 1992 to 2002.
Is the current framework appropriate for the post-virus world of today? Are central banks better able to focus on other priorities than inflation?
The Bank has avoided these hard questions until now by claiming that inflation at the moment is temporary, an induced pandemic phenomenon that will eventually disappear.
It has been increasingly difficult to believe that this is possible. Covid is a factor in some components such as the supply chain bottlenecks or the soaring energy costs.
There are however reasons to believe that longer-lasting inflationary forces may be at work in the UK as well as in other advanced economies.
Trade union demands for excessive pay increases in order to maintain a high standard of living were a major factor in the 1970s’ runaway inflation.
Although unions have a diminished influence, they are still a powerful force. Millions of people are still members, and they are more likely to continue agitating for better settlements in the event that high inflation persists.
The pandemic has brought out a lot of positives, including a strong labour market and low unemployment.
However, there are skills shortages in certain sectors. However, it hasn’t led to salary increases that are ratcheting, although this could change in the near future.
Covid-19 makes individuals and governments much more aware of their health.
It is especially true in countries with aging populations such as ours, which could cause a rise in the cost of medicines and care.
There is also the phenomenon of ‘greenflation’ – the rising cost of fighting climate change. Already this year, we have seen copper and other metals, essential for green technology, rise to new records.
And again, a shortage of skilled labour for environmentally-friendly energy projects is likely to push up wages.
No less a figure than Larry Fink, the boss of the world’s biggest money manager Blackrock, has warned that going green will bring ‘much higher inflation’.
One reason inflation has been low in recent decades is globalisation – the ability of goods, capital and people to move freely across borders.
Pandemics have exposed the flaws in this model. Higher prices will result if trade barriers are removed.
Many policymakers were caught off guard by the sudden resurgence inflation within the pandemic.
Andy Haldane was the Bank’s former chief economist. He warned his colleagues in spring about the dangers that the genie might escape the bottle. His coworkers preferred not to pay attention until now.
The question of whether interest rate hikes can be used to combat inflation from global supply chain problems and rising energy costs is still open.
It’s a fair point. However, raising rates can still be a powerful means of communicating a message, as yesterday’s shock and awe show. It has boosted the Bank’s credibility as an inflation-fighting force.