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The Bank of England governor signalled on Wednesday he was concerned about the possibility of weakening demand in the UK economy, a key reason he believed the country should stay on track for slowing inflation.
While the BoE had predicted consumer prices inflation will accelerate to 3.7 per cent this year from 3 per cent in January, Andrew Bailey told MPs that he believed the “underlying path” of price growth was still downwards.
He played down the risks of a self-reinforcing acceleration in price growth given the “weakening pattern” of the UK economy, adding: “It is nothing like what we saw a few years ago.”
Bailey added: “The demand weakness argument may be getting a bit stronger relative to last year, but we will see.”
The BoE lowered interest rates to 4.5 per cent in its February meeting even as it warned that rising commodity prices including energy were set to drive inflation higher this year.
A major question facing the central bank is whether recent weakness in the economy is primarily attributable to a weak supply side of the economy or to softening demand, the latter of which could help drag inflation lower.
The hearing before the Treasury select committee laid bare the divisions within the BoE’s Monetary Policy Committee over the degree to which inflation risks are receding.
While Bailey played down the risk of “second-round effects” reigniting inflation, external MPC member Megan Greene and BoE chief economist Huw Pill were less sanguine about price growth.
Greene noted in a letter to the committee that 2025 was likely to be the fifth consecutive year in which inflation remained above the Bank’s 2 per cent target.
“There is a risk this may have lowered the threshold for second-round effects taking hold,” she said.
Greene added that soft economic activity could be “primarily supply-driven”, adding “it’s less likely inflation persistence will fade on its own accord, and more likely monetary policy will need to remain restrictive”.
Pill told the committee he would not support a more rapid pace of rate cuts given ongoing inflation risks. “I do not have yet full confidence that we have squeezed all of that out,” he told MPs.
Bailey stressed the increasing risks facing the UK now because of the tariffs being imposed by the US on its partners. The direct impact on inflation was “ambiguous”, he said, but “the risks to the UK economy — and indeed the world economy — are substantial”.
He argued the best way of tackling imbalances such as trade deficits was via multilateral forums, rather than via “bilateral action”.
Among the many uncertainties facing the BoE are problems with the labour market data being produced by the Office for National Statistics. Bailey said he had questions about other areas of the official statistics, highlighting the striking weakness in public sector productivity data.
Healthcare productivity, a measure of the efficiency with which labour and capital are used to deliver NHS services, fell by an annual rate of 2.4 per cent in the third quarter of 2024, according to data “in development” published by the ONS last month. It was estimated to be 18.5 per cent below its pre-pandemic peak in the final quarter of 2019, the agency said.
Bailey called the figures “both striking and puzzling”, stressing how difficult it is to measure output in the public sector.
“There is a real question — is this real or is it something to do with measurement,” he said. Bailey added that if productivity had stayed level or stuck to its pre-2019 trends the upward impact on GDP would be “not trivial at all”.
