Andrew Bailey, the Governor of the Bank of England, admitted last week that “to forecast 10 per cent inflation and to say there isn’t a lot we can do about it is an extremely difficult place to be… This is a bad situation to be in.” It’s the sort of thing that Captain Edward Smith might have argued a little over a century ago had he not gone down with the Titanic. “To spot an iceberg right in front of us and to say there isn’t a lot we can do…”
Bailey suggested that many of the criticisms of the Bank’s recent inflation record were being made only with the benefit of hindsight. How could anyone know, in advance, that Russia would invade Ukraine, that energy prices would soar, that food shortages would develop, or that China would lock down its economy again, thus disrupting global supply chains?
You could imagine Smith making similar arguments. The Titanic was designed to be the safest ship ever built. It was supposedly unsinkable. An iceberg, no matter how big, was no match for such a marvellous feat of engineering. Yet Smith and his crew were complacent, continuing to sail along at a rate of knots as the ship entered an area of the Atlantic known to have icebergs. Radio warnings from other ships were mostly ignored. Without binoculars, the lookouts in the crow’s nest spotted the Titanic’s very own iceberg too late.
You don’t need hindsight to know that Smith and his crew could have done a better job. And I’m not sure you need hindsight to know that the Bank of England could have spotted its own inflationary iceberg much earlier than it did. I warned in this column a year ago that interest rates would need to rise much further than central banks at the time were indicating.
Inflation was already becoming a problem. To blame increasing price pressures mostly on Russia, Ukraine and China is an act of convenience, not a reflection of hard-nosed analysis. While the Bank of England sensibly delivered loose monetary conditions in response to a collapsing world economy in spring 2020, it thereafter delayed reversing course even as lockdowns ended and demand, inevitably, accelerated. Surging asset prices were mostly ignored, even though the huge gains signalled that spending would pick up. And, even as parts of the western world unlocked, it was clear long before China’s latest lockdown that supply chains were not going to return to pre-pandemic normality any time soon.
For the UK, there were additional tell-tale signs. Vacancies surged all the way through last year, reaching unprecedented levels. Unemployment tumbled. Wages accelerated. Yet the binoculars on the Bank of England’s crow’s nest had seemingly gone missing. Too much demand, too little supply yet, somehow, official interest rates only started to budge in December.
Like a ship’s captain, a central banker’s job is, in a broad sense, one of navigation. The task is to steer the economy in such a way that the icebergs of inflation, deflation and financial upheaval are avoided. Yes, central banks have to make decisions in incredibly uncertain circumstances and, as such, are likely to make the occasional mistake. To minimise the effects of these mistakes, however, it’s important to keep an open mind and recognise that sometimes a shifting balance of risks demands a firm hand on the monetary tiller. With inflationary pressures building both at home and abroad, the opportunity was there. It was taken only belatedly.
What now? With prices rising faster than wages and benefits, the Chancellor Rishi Sunak can help the most vulnerable if he so wishes. Those most in need can be offered fiscal support via tax cuts and benefit boosts. All worthy stuff, of course, but the Chancellor finds himself in a position equivalent to the deckchair attendant on the Titanic. He can make life more comfortable for people in the short run but, on his own, he’s not really in a position to change the ship’s course.
That, I’m afraid, is largely the responsibility of monetary policy. At the moment, the Bank is delivering only the most gentle of policy adjustments: at one per cent, official interest rates are still incredibly low compared with the current nine per cent inflation rate. And with the labour market now so tight, it’s not difficult to imagine the beginnings of what used to be termed a “wage-price spiral”. If so, the Bank may be forced into making a far more abrupt change of course.
