Bank of England official warns of higher inflation if UK rate rises lag US

One of the Bank of England’s more hawkish policymakers has warned that the UK faces further rises in inflation if the central bank fails to increase interest rates as rapidly as the US Federal Reserve, causing the value of the pound to slip.

Speaking online at a Market News International event, Catherine Mann said that a fall in sterling risked exacerbating high UK inflation, which she said five times was no longer just imported but “embedded” in companies’ domestic pricing decisions.

With the official inflation rate likely to edge higher from 9 per cent for April when the May figures are published on Wednesday, further price rises coming from the weakness of the pound would intensify the cost of living crisis, said the external member of the bank’s Monetary Policy Committee.

The pound, trading at $1.2232 on Monday afternoon, has lost 11.4 per cent of its value against the US dollar over the past year, although it has been broadly stable against the euro.

With inflation already set to rise to more than 11 per cent in the autumn, Mann said further falls in sterling would be likely if the BoE raised interest rates much more slowly than the US Fed, which in turn would push up inflation further. The BoE raised UK rates by an expected 0.25 percentage points last week to 1.25 per cent.

Mann, who had voted for a 0.5 percentage point rise last week, accepted that tightening policy quickly could hurt economic growth, but she thought the overall outcomes would be better if the BoE acted quickly to defeat inflation and then reversed course.

“A more robust policy move . . . reduces the risk that domestic inflation . . . is further boosted by inflation imported via a sterling depreciation,” she said. “I open the door to a policy rate reversal in the medium term when the domestic supports to demand fade and when weakness in external sources of demand bite.”

With the BoE having failed to predict the rise in inflation from 1.5 per cent in April 2021 to 9 per cent a year later, Mann said it was now evident that inflation was part of the normal process of UK companies setting prices.

Unlike BoE governor Andrew Bailey, who has said that 80 per cent of price rises came from abroad and the central bank could do nothing about them, the external member of the MPC said that “the incoming data on inflation show increasingly domestic embeddedness, persistence and momentum”.

She said that of all the items measured by the Office for National Statistics, prices for nine in 10 of them were now rising faster than they had between 2012 and 2019.

She thought that incomes were being hit, but spending might prove to be more resilient, further embedding inflation, particularly if the BoE was seen to be reluctant to tighten monetary policy.

In what she called an “extremely stylised” model, she noted that when the Fed typically raised interest rates by 1 percentage point, sterling would fall because the BoE would not follow suit and UK prices would rise another 0.5 per cent.

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