BOE Governor Andrew Bailey Talks Rates, War, Inflation, Markets

Bailey Signals Another Rate Rise Unless Energy Prices Fall

The Bank of England is keeping another rate rise in play, and Bailey's case rests on energy prices and an unsettled Middle East conflict rather than on a weak economy. UK activity has run firmer than forecast, with business services and AI-related investment doing much of the work. Because the energy price cap locks in much of the coming inflation, even a peace deal would bring less relief than households expect, and Bailey will not endorse the hike markets have priced.

Takeaways

• Another rise is probably more likely than not. Bailey says that if there is no progress on settling the conflict and energy prices stay where they are, another rise is probably more likely than not. He hopes for progress and will not predict how it maps into rates.
• Bailey declines to endorse market pricing. The Bank surveys markets at every meeting for their central expectation of what it will do, then compares that with how they are pricing. The gap is the risk premium. Markets expect one more hike, which Bailey does not endorse.
• AI accounts for a fifth of firmer activity. UK activity has been firmer this year than the Bank expected, concentrated in business services. Staff analysis suggests AI accounts for about a fifth of it, consistent with capital deepening to enable AI. Business investment is the stronger element of growth.
• Bailey judges restraint through financial conditions. Bailey weighs financial conditions as well as the bank rate when deciding if and when to move. UK mortgage rates have risen by one of the largest amounts in the G7, evidence for economists who argue rates have not been restrictive enough.
• Energy price cap bakes in inflation. Because of how the household energy price cap is calculated, much of the coming inflation increase is already locked in, and a lot of the first-quarter number is in the bag. The central forecast still has inflation falling quite fast.
• Rate cuts expected last year never came. A year ago the Bank was expected to cut rates this year, which Bailey thought reasonable before the conflict began. That expectation shifted in March, and the absence of cuts was no great surprise.

If the conflict settles

• Inflation would not rise to 5% if the conflict is settled, Bailey says.
• Households would still not get as much relief as they imagine, because so much is baked into the price cap.
• The central forecast already has inflation coming down quite fast, and the question is whether it falls faster.
• The Bank will watch pass-through into food and other prices, and whether stronger activity feeds inflation regardless of energy.