Bank of England's test of will

The Bank of England (BoE) is caught between the devil and the deep blue sea. The BoE is nominally independent, so in theory shouldn't have to deal with political arm-twisting. But inevitably in the over-stuffed leather armchairs of clubland London, senior BoE staffers will rub shoulders with politicians. They will hear their wails against heading into the election year of 2024 with a recession in full swing, with unemployment, mortgage defaults, businesses collapsing and perhaps street protests all a consequence of an economic slowdown. The BoE espoused the 'inflation is transitory' line very early on. Now that has been proved well and truly wrong, after this week's shocking inflation report, its credibility is being tested.

UK headline inflation remained stuck at 8.7% in May. Bad enough, but even worse was that 'core' inflation (excluding food and energy prices) actually rose to 7.1%, the highest since 1992. So the BoE has pushed its base interest rate up by 0.50% to 5%, the 13th successive rate rise. The Monetary Policy Committee (MPC), an adjunct of the BoE which sets rates, voted 7-2 in favour of this rate rise.

UK headline inflation remained stuck at 8.7% in May. Bad enough, but even worse was that 'core' inflation (excluding food and energy prices) actually rose to 7.1%, the highest since 1992.

What are we to make of this belated rate rise? Sadly, it won't be enough to stifle inflation. Even a 5% interest rate still leaves rates in 'negative' territory, 3.7% behind inflation. To be truly dedicated to snuffing out inflation the BoE should push rates above 9%, i.e. above inflation. Base rates at 9% would however mean the rates that most mortgage holders pay would be around 10%; that would cause misery and bankruptcy for an untold number of the 3.4 million UK mortgage-holders who are moving off a fixed-rate deal this year. As it is many will find great difficulty paying mortgage bills at around 6%.

What is causing this stubborn inflation? As Stephen D. King points out it in his new book We Need To Talk About Inflation, "the roots of the post-pandemic rise in inflation lie in...monetary complacency, not in Russia's invasion of Ukraine in 2022 or China's ongoing Covid lockdowns." King sees the roots of this inflation as the exceptionally loose monetary policy post the Great Financial Crash of 2008, when the big fear of central bankers was deflation - so in combination with government policymakers they flooded the world with cash, ironically to fend off a recession. Now they have no choice but to condemn societies to a recession; further rate rises are inevitable, even though a rate rise takes two years to feed through to the economy. How bad will it get?