He believes the UK is not really in control of its own inflation destiny as global factors will play a part.
Oliver Jones, asset allocation strategist at Rathbones, says the Bank of England may have been trying to tell investors today that interest rates may peak at a lower level than has been priced into markets, but he is cautious.
According to Jones, the risk of inflation staying higher than the BoE expects remains significant, despite the government’s recent swing from fiscal expansion to contraction.
He says: "The BoE itself judges that the risks to its inflation projections are to the upside, with Governor Bailey in his press conference suggesting that these risks may be the largest in the history of the monetary policy committee.
"The labour market is still exceptionally tight.”
Supply weakness
Jones believes a key problem is the lasting weakness in supply since the pandemic, with hundreds of thousands of workers dropping out of the labour force, many due to long-term sickness.
With firms competing for a smaller pool of workers, wage growth has risen to 6 per cent, higher than the BoE previously forecast.
He explains: "The ratio of unfilled job vacancies to workers is also still exceptionally high, and the unemployment rate is near its lowest in half a century.
"Households’ and firms’ inflation expectations are also worryingly high. The Citi/YouGov measure of households’ long-term expectations remains above 4 per cent.
"And the BoE’s decision maker panel survey of businesses shows that they plan to keep increasing prices and wages at rapid rates (6.7 per cent and 5.9 per cent respectively) in the coming year.”
Inflation would usually be expected to fall during a period of prolonged recession as a result of the level of aggregate demand in the economy falling.
Economies are comprised of supply curves and demand curves, inflation happens when the demand curve is steeper than the supply curve, ie that demand is rising faster than supply, while recessions happen when the supply curve is rising faster than the demand curve.
Recessions reduce demand, causing suppliers in an economy to reduce supply, to match this, eventually this leads to the supply and demand curves tilting roughly in parallel.
But much of the present inflation in the economy is focused on supply side factors which are less susceptible to demand declines, such as energy prices, meaning inflation and recession, a phenomenon known as stagflation, can happen at the same time.
Barnes adds the outlook for UK inflation has not been materially changed by today’s Bank of England comments.
