Bank of England officials will be watching closely the progress of the race to replace Boris Johnson as Tory leader and prime minister.
In normal times, central banks should pay little attention to the political ups and downs that keep politicians busy in the tea rooms and bars of Westminster. These are not normal times. Inflation has hit 9.1% and bank employees are under pressure to raise interest rates to squeeze the economy and with it inflationary pressures have pushed up prices.
Before last week’s political drama unfolded, Johnson and his now-former chancellor Rishi Sunak were due to hold a press conference this week detailing how the government’s tax and spending policies would develop over the next six months.
In his resignation speech on Tuesday night, Sunak said he had not been able to agree a way forward with Johnson, who wanted to announce big spending on defense and welfare. Sunak could not support it if it had not been funded by tax increases. It is understood that Johnson wanted to marry his extra spending with a tax cut, to increase the amount pumped into the economy.
Sunak argued with the number 10 that economics at this time was a zero-sum game. Any increase in spending would be deemed inflation by the bank, prompting Threadneedle Street to raise the cost of borrowing even more than previously estimated.
Now the same debate will be played not between enemies in No. 10 and No. 11 Downing Street, but between rival candidates in the campaign for Johnson’s successor.
Last week, the bank’s chief economist, Hu Pill, said the policy change meant it followed a policy of “more strict”, under which the bank would increase borrowing costs in small and steady increments. A more flexible policy that could result in a bigger jump in interest rates. “Acting To Get” [monetary policy committee’s] The 2% inflation target is now more important than ever,” he said. “MPC is committed to return inflation to target in a sustainable manner over the medium term. In the first instance, it requires – and still requires – strict monetary policy.”
Pill said he was worried the UK economy was slowing and could face a contraction – a development that would persuade him to cut or even cut rates. “But it also requires that the tightening be measured and proportionately calibrated appropriately to the economic situation at hand,” he said.
It is possible that when the annual energy price cap rises from £800 to around £2,800 in October, inflation will rise above 11% and the cost of living crisis will worsen.
However, other factors, including the government, under its new leader, are pumping billions into the economy through sudden tax cuts and welfare spending. Delegating additional spending power to the people will drive up prices when the supply of goods and services is constrained by labor shortages and hard-to-find imports.
Pill declined to comment on the possibility of a change in government spending policy during a question-and-answer session at King’s College’s global banking and finance conference in London last week, but the bank’s response indicates his champion of greater flexibility. that he and his associates will be watching Westminster closely.
Pill’s colleague on the bank’s monetary policy committee, Catherine Mann, is already keen to sharply raise the base rate to 1.25%, which many economists in the city believe could be 3% by the end of next year. Is.
Mann is concerned about a 12% drop in the value of the pound since January, with much of its decline on the UK’s lack of recovery from the pandemic. She attributes the increase in inflation to rising import costs coming from a weaker currency.
But without a coherent and comprehensive plan from a new Tory leader that investors can agree is going to create a sustainable path to growth, the pound could fall even further, with the central bank to raise rates and can exert even more pressure.