As the UK’s economy has dealt with the blows of the Covid pandemic and Russia’s invasion of Ukraine, the Bank of England has had to roll with the policy punches in its effort to pursue financial and economic stability.
Amid an atmosphere of enduring conflict in the East and inflationary pressures, Bank of England governor Andrew Bailey spoke with Breugel director Gundstrom Wolff, laying out the present environment in the UK and how policy can stabilise finance, the economy and currency in the wake of a large-scale military clash, a pandemic and the UK-specific development of Brexit.
Bailey said that the present “shock from energy prices” was historic, greater than any single year of the inflation-stoked 1970s, albeit with the caveat that that decade featured several rough years in succession.
“In the UK, and indeed elsewhere, we are very much facing a very large shock to aggregate real income and spending. That is not something that we have a policy toward that can make it go away,” Bailey said. “It’s coming through energy prices, through imported goods, through some food and is very much what we’d tend to call trade shock in that sense. Inflation measures are well above target. Unfortunately, I think it’s best to think that there is some more to come on that front.”
“We expect it to cause growth and demand to slow. We’re beginning to see the evidence of that in both consumer and business surveys,” Bailey added.
Tradeoff, unconventional shocks
Bailey said that the Central Bank’s goal was to return inflation to its target “a couple of years out” and ensure that real adjustment occurs sustainably with minimal volatility and disruption. Bailey also said that the BOE and its contemporaries around the world remained committed to a globalised, integrated economy, much as they were during the widespread financial crisis more than a decade ago.
Bailey focused primarily on the disruptions of the pandemic and the dispute between Russia and Ukraine, stating that those two globally impactful events overshadowed and muddied any comprehensive analysis of Brexit’s effects on the UK’s economy and trade.
He said that thus far he felt the Central Bank’s planning had been effective in the face of the harrowing Covid era, the calmer-than-expected Omicron variant period and pandemic recovery, which resulted in a tight labour market and an unforeseen buildup of personal savings.
He said, however, that those with fewer economic means bore a disproportionate brunt of the current circumstances because they did not benefit generally from the surge in savings while simultaneously experiencing greater exposure to rising energy costs.
A resolution to the crisis in Ukraine would go a long way toward solidifying the UK’s position and stabilising energy and commodities markets, Bailey said, though near-term pressure could make the situation worse before it improves.
Now approaching a month old, the conflict has brought a deluge of question marks, which Bailey said caused the BOE to revise its guidance regarding “further modest tightening” in the form of interest-rate hikes from “likely to be appropriate” to “may be appropriate.”
“We’re facing a very big shock, by any historical standard. We’ve got a very large tradeoff between inflation and output activity, with the two moving in opposite directions. There is a very high level of uncertainty,” Bailey said.
Behind the curve?
In prior instances of market shock, Bailey said that the current policy would be behind the curve, facing pressure to accelerate counter-inflationary measures, including rate hikes.
However, he said, this was not a typical instance of a demand shock, with some favourable economic indicators as well as the large scale of the disruptions giving some pause and cause for caution to policymakers.
“We’ve got a pandemic followed by a European war, on any scale that is a very difficult position to be in for policy. The task we have is clear, but it’s hard, but we will stick to it and all central banks are committed on that front,” Bailey said. “In our case, it’s appropriate to tighten policy in these circumstances, but we do so recognising the uncertainty.”
Forex implications, long-term prognosis
Bannockburn Global Forex chief strategist Marc Chandler assessed the broader strategy in the UK and its impact on the pound, which has produced a mixed forecast and tepid results in recent days even as stable currencies have been attractive to risk-off investors.
“Sterling has underperformed here in March. It is the second weakest major fx, off 2.45%, well less than the Japanese yen’s 7.1% decline. The Bank of England hiked rates but softened its guidance, and the market does not think it can keep pace with the (US Federal Reserve),” said Chandler, noting that the US two-year premium over the UK doubled in March, around 100 basis points and that he saw the pound as “heavy,” poised to drop to $1.28 or $1.29 from its present position near $1.38.
Bailey emphasised repeatedly the need for collaboration among central banks around the world in a globalised economy. Yet as tones grow more hawkish in many countries, including the US and Canada, the UK has opted for prudence.
“At the end of the day, Bailey talks like a hawk and acts dovishly,” Chandler said. “There are shades of former Bank of England governor Mark Carney, who was often talked about as the bad boyfriend who over-promised and under-delivered.”