UK Inflation Risk Looks More 2011 Than 2022 for Bank of England

When Britain was last hit by a major energy shock after Russia invaded Ukraine in 2022, the Bank of England cranked up interest rates to chase down spiraling inflation. This time is different.Author of the article:You can save this article by registering for free here. Or sign-in if you have an account.(Bloomberg) — When Britain was last hit by a major energy shock after Russia invaded Ukraine in 2022, the Bank of England cranked up interest rates to chase down spiraling inflation. This time is different.Subscribe now to read the latest news in your city and across Canada.Subscribe now to read the latest news in your city and across Canada.Create an account or sign in to continue with your reading experience.Create an account or sign in to continue with your reading experience.Four years ago, the spike in prices hit an overheating economy. Unemployment was at a 48-year low, vacancies were at a record high and wages were growing at the fastest pace this millennium. Households had pandemic savings to spend, the government was stoking demand and rates had just come off a record low of 0.1%.Today, unemployment is rising, vacancies falling, growth stalling and both monetary and fiscal policy bearing down on activity. Economic policy had its foot on the accelerator in 2022, urging inflation to its 11.1% peak. Slamming on the brake was the obvious response. Policy already has its foot on the brake now.Get the latest headlines, breaking news and columns.By signing up you consent to receive the above newsletter from Postmedia Network Inc.A welcome email is on its way. If you don't see it, please check your junk folder.The next issue of Top Stories will soon be in your inbox.We encountered an issue signing you up. Please try againInterested in more newsletters? Browse here.“These are not the conditions of 2022 all over again,” said Simon French, chief economist at Panmure Liberum.At its interest-rate decision on Thursday, the BOE will likely signal whether it agrees. Before US and Israeli strikes on Iran brought Persian Gulf oil and gas traffic to a standstill, it had looked like the nine-member Monetary Policy Committee would have backed a quarter-point cut to 3.5%. Markets were pricing one further cut later this year.They are now betting there will be no cuts. Instead, traders are fully expecting a rate rise back to 4% by December. Economists unanimously expect rates to be held this week.Alongside the decision, the MPC will provide an initial assessment of the Iran conflict, which has driven up oil prices 42% and gas prices 57% since Feb. 28. It is likely to echo Office for Budget Responsibility economist David Miles, who last week told lawmakers higher energy costs will add about a percentage point to inflation — lifting consumer-price growth in the second half of 2026 to 3%, from the 2% forecast before the war.But Miles cautioned “it’s not clear which way we go from here.” Similarly, the bank’s guidance is likely to stress the unpredictability of events.For David Aikman, director of the National Institute of Economic and Social Research, the current situation is “more 2011 than 2022.” Rising oil and commodity prices drove inflation to 5.2% in 2011, but the MPC didn’t respond.The committee looked through the shock, assuming tighter policy “would increase the chances of undershooting the target in the medium term,” then-Governor Mervyn King said in a letter to the Chancellor of the Exchequer. His point was that the economy was weak enough, high energy prices would weaken it further and rate rises would have simply piled on more unnecessary misery.Similarly, the MPC’s attention had been shifting to rising unemployment — now at a five-year high — before the Iran war. Inflation was a receding threat, still at 3% but on track to hit the 2% target by April. Household expectations of inflation were also coming into line, falling to 3.2% last month from 3.5% in January. Now, there are fears for both the labor market and a fresh burst of inflation. The war has “revived a familiar dilemma for central banks: tackle inflation or support weaker demand,” wrote Ana Andrade and Andrej Sokol, economists at Bloomberg Economics. Using a bespoke economic model, they estimate there is a 75% chance that unemployment rises above the bank’s forecast of 5.3% by mid-2026.Under the model, employers stop hiring because higher energy costs squeeze consumer spending and growth. The risk is rising that unemployment then “prompts a bigger pullback in consumer demand, pushing the jobless rate even higher,” Andrade and Sokol said. If the BOE anticipates this behavior, it “will likely temper the scale of any hawkish pivot” in response to higher inflation. Much as it did in 2011.Today’s labor market could scarcely be more different than at the last energy shock. In 2022, employers could not get hold of staff, so they hoarded what they had and paid up for recruits.Vacancies hit a record 1.3 million and unemployment fell to 3.6% in the summer of that year. Earnings growth topped 8% the following summer. Workers had a level of bargaining power that no longer exists.Vacancies have almost halved since 2022 to 726,000, about 600,000 more people are unemployed and companies are no longer hoarding staff. Moreover, rates of 3.75% are squeezing growth and the public-sector impulse is fading as the government borrows less this year.Added to which, energy prices were determined by the marginal gas price 90% of the time in 2021. That’s fallen by about a third, meaning the UK is less exposed to the energy price peaks of the past, Chancellor Rachel Reeves told lawmakers last week.The scenario economists fear is that BOE cannot look through the latest shock because inflation is already elevated at 3% and memories of double-digit price growth are still front of the public’s mind. Paul Dales, chief UK economist at Capital Economics, said energy prices tend to have a big effect on inflation expectations and that the BOE was particularly “alert” to the risk that workers may respond by demanding bigger pay rises, trapping the UK in another wage-price spiral.Recent internal BOE analysis found that once inflation reaches 3% to 4%, there is a high chance it gets stuck. Raja added that sharp criticism of the bank after letting inflation climb to 11.1% four years ago will shape its priorities. “The labor market story, we think, will take a back seat — at least for now,” he said.Like Andrade and Sokol, French was less convinced that the bank’s recent past would determine its future. “The bar is currently set quite high for a 180-degree pivot towards interest-rate hikes,” he said. “Monetary policy is already restrictive, demand is tepid, and sterling has held up well so far.” The optimistic version of events is that the war ends soon and energy markets settle down. “If the shock proves short-lived and recent price rises fully reverse, we still think there’s a reasonable chance that the MPC will resume its cutting cycle either in April or June,” said Edward Allenby, senior UK economist at Oxford Economics.—With assistance from Irina Anghel and Andrew Atkinson.Postmedia is committed to maintaining a lively but civil forum for discussion. 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