The Bank of England has failed to control inflation

• Ukraine’s Zelensky said his country’s counter-offensive was going “slower than desired”.
• The death toll from a riot in a women’s prison in Honduras rose to 46.
• Ben Wallace, the UK’s defence secretary, said he won’t be Nato secretary general.

The Bank of England will raise interest rates today by a quarter or half a point, and will probably signal a further series of rate rises.

The immediate cause is the worst inflation in the G7.

The immediate effect will be pain for homeowners, especially younger ones; pain for businesses, especially indebted ones; and pain for Rishi Sunak’s government, which may have to accept an engineered recession as the only way to keep its promise of cutting inflation by half.

So what? It didn’t have to be like this. 

British inflationary exceptionalism has myriad explanations but one of them is human error. Central banking cognoscenti are now virtually unanimous that Andrew Bailey as governor of the Bank of England has

• persistently underestimated the risk of inflation taking hold;
• failed to act fast or decisively enough to rein it in; and
• failed to communicate effectively to markets his determination to do so.

He had one job. The bank’s governor’s main task since 1992 has been to target inflation of around 2 per cent. Ever since the bank was handed its independence in 1997, how to accomplish this task has been left in principle to governors and their advisors. Despite that singular focus Bailey is now accused of multiple failings under at least four headings.

Bad calls. Hindsight is 20/20, as Bailey reminds his critics. Even so… 

• Unlike Sunak (then chancellor) and his own chief economist, Andy Haldane, he failed to see in 2021 that prices were going to rise and go on rising. Instead he said in June that year it was “important not to overreact to temporarily strong growth and inflation” and in September that inflationary pressures would be “transient”.
• When Haldane left the bank warning that the inflationary genie was “out of the bottle”, he was ignored.
• When Sunak’s furlough scheme to protect jobs from Covid was wound up in late 2021, “we thought unemployment would rise,” Bailey told a House of Lords Economic Affairs Committee hearing this month. “Frankly, we were wrong.”
• That misjudgement of the labour market was matched by another of the effect of quantitative easing, reintroduced to pay for Covid support schemes. Bailey “relied too much on low inflation expectations built up over quarter of a century,” writes David Smith. He forgot that past performance is not a safe guide to the future. 

Weak models. Mervyn King, a former bank governor himself, noted at the same committee hearing that the bank’s dominant model for inflation forecasting “basically builds in the view that inflation is always and everywhere a transitory phenomenon”. Bailey admitted King was right. He said the bank’s modelling also suffered from being “highly linear and highly symmetric” at a time of huge external shocks, including war. So the bank has fed more “persistence” into its model – but that didn’t stop Bailey forecasting a “sharp fall” in inflation as recently as March.

Groupthink. Bailey chairs a monetary policy committee (MPC) of largely like-minded economists used to negligible inflation, ultra-low rates and high volumes of QE, with little discussion of monetary policy’s impact on inflation. Hence a recent accusation from Brian Griffiths, a former policy director for Margaret Thatcher, of “wilful neglect of handling money, despite the fact that in the 18th, 19th and 20th Centuries money [supply] has played an important role in many people’s view of inflation”. Translation: if you print money, expect inflation.

Bad comms. Expectations are a key driver of inflation because if workers think inflation targets aren’t going to be met they will press for wage increases to compensate. The bank’s communications in turn form expectations, so their credibility is vital. Bailey’s have been variously vague, wrong and behind the curve.  

He and the UK government prefer to blame external shocks for inflation (war, Covid and supply chain disruptions resulting from them). It’s true these have been unprecedented and largely unforeseeable. But their impact has been global and Britain’s problem is exceptional. 

• UK inflation as measured by the consumer price index is at 8.7 per cent compared with 6.1 for the eurozone and 4 in the US.
• UK core inflation, excluding food and fuel, rose yesterday to its highest level since 1992. At 7.1 per cent it’s nearly two points higher than in the eurozone or the US and in the bottom five of the G20.

Bailey’s modelling has undershot actual inflation by an average of six percentage points since 2021. His models and decision-making are now under review at his own request. In the meantime mortgage holders, business borrowers and the government are at his mercy. 

Further listening: James Cleverly, Britain’s foreign secretary, was unable to answer a question about the government’s plans to bring down inflation. Listen from 1:53:30.