Bank of England Governor Declares UK Inflation Turning a Corner

Bank of England Governor Andrew Bailey said that the UK's headline inflation rate has declined for two months, which may be a sign that the economy is improving.

In an interview with the Western Mail published on the BusinessLive website Thursday, Bailey said that the recent uptick in inflation is likely just a temporary phenomenon.

"What we think is the most likely outcome is that it (inflation) will fall quite rapidly this year, probably starting in the late spring," he said. Bailey attributed the expected drop in inflation to falling energy prices.

According to the comments, central bank officials may be considering when to end the quickest monetary tightening cycle in three decades. Policy makers have lifted the key lending rate nine times since December 2021 to control soaring prices that have squeezed household budgets.

While the BOE remains concerned about inflationary pressures in the labor market, Governor Mark Carney noted some signs that rapid wage growth may be about to cool.

"I think the news on pay is mixed," Bailey said. "There are some signs that it is still rising, but some of the forward-looking surveys of earnings and pay are not as strong as that. We are extracting every piece of information that we can possibly find."

This week's official figures showed that inflation cooled for a second month in December, falling to 10.5% from a 41-year high of 11.1% in October. Another report showed that wage growth hit the highest on record except for the period right after the pandemic started.

The governor warned that the economy is sluggish enough to prompt a "long but shallow recession." He is concerned about the tightness of the labor market and the impact that will have on inflation.

I've been speaking with businesses in South Wales, and I'm hearing a lot of stories about how competitive the labor market is, even though the economy has been quite weak in recent times. This is having an impact on pay negotiations, according to Bailey.

He noted that the UK is facing an "unprecedented and unique" decline in the labor force, with at least 500,000 people leaving the workforce since the pandemic began.

"Unemployment has increased slightly, but it is still at historically low levels," Bailey said. "We have seen a rise in inactivity and the labor force has shrunk, which is putting pressure on the labor market and leading to higher wages and inflation."

Bailey suggested that market interest rate expectations are now more closely aligned with the BOE’s thinking on where borrowing costs peak. Investors are betting on another 1 percentage point increase in the benchmark lending rate to 4.5% — including a half-point hike in February. This is in line with the BOE’s own predictions, and suggests that investors are confident in the central bank’s ability to manage inflationary pressures.

"I am not endorsing 4.5%, but what you may have noticed in December is that we did not include the comment that we made in November about the market being in our view rather out of line," Bailey said.

He emphasized that the UK is still recovering from the Covid pandemic and that the outlook is more unsettled than usual.

"People always talk about the rapid recovery from the worst of Covid," Bailey said. "The economy went off a cliff, but it has come back up somewhat. However, since then it has been a pretty grinding process."