BoE warns against inflation psychology amid 'uncomfortable' situation for UK

In a speech released this morning (May 20), Huw Pill said the Bank of England's monetary policy committee needs to ensure domestic price-setting does not achieve a "self-sustaining, expectationally-driven momentum" which would maintain inflation at the current high levels.

This could happen despite a lowering of commodity prices and rise in unemployment, he said.

“Avoiding any drift towards the embedding of such ‘inflationary psychology’ into the price setting process is crucial.”

According to online investment dictionary Investopedia, inflationary psychology is a state of mind that leads consumers to spend more quickly than they otherwise would in the belief that prices are rising. 

The BoE is doing something, even if it's potentially the wrong thing, because it can't be seen to be doing nothing.Scott Taylor-Barr, Carl Summers Financial Services 

He explained: "On the one hand, there is a danger that the current high level of inflation becomes embedded in wage and price setting behaviour, imparting greater persistence to the upside deviation of inflation from target in the coming years,” he said.

“On the other hand, the squeeze on real household incomes coming from higher energy and goods prices threatens to weigh heavily on demand, activity and employment, potentially adding to the undershoot of the inflation target forecast by the MPC at a three-year horizon.”

Pill said the UK economy is in an "uncomfortable situation" with inflation for the 12 months to April sitting at 9 per cent and he acknowledged these are difficult times for a lot of the population.

He added there are risks on both sides to the MPC’s remit of maintaining price stability in the UK as well as inflation at a rate of 2 per cent.

Pill said the current high level of inflation is being caused by Brexit reducing the number of overseas workers contributing to the UK economy, as well as globalisation stalling and reducing the competitive pressure on UK producers to keep costs low.

It's time to look at restructuring debt to mitigate the inevitableGraham Wells, GroWiser Financial Coaching

The high prices are also potentially being caused by the impact of ageing and longer-term health consequences of the pandemic leading to a decline in the numbers in the UK labour force.

He said he is worried that the MPC’s attempt to ‘fine tune’ economic and price developments will introduce more volatility into inflation as not enough is known about the intrinsic mechanics of the economy and inflation.

Scott Taylor-Barr of Carl Summers Financial Services said small businesses must be feeling like the government is trying to force them out of business.

"I have the impression that the Bank of England is doing something, even if it's potentially the wrong thing, because it can't be seen to be doing nothing.

"Small businesses up and down the land have had to shoulder lockdowns, global supply chain issues and staffing issues, not to mention the ever-present threat of Amazon decimating their markets like locusts in a corn field.

"Now they are potentially being asked to pay even higher costs on their outstanding borrowing, too."

Graham Wells, financial coach at GroWiser Financial Coaching added that the real pain will be felt by businesses and individuals with variable rate loans, overdrafts and credit cards.

"There's no doubt that interest rates will continue to rise and the impact will hit people in different ways," he said.

"A half percent rise, which is now very possible, could really eat into disposable income, so it's time to look at restructuring debt to mitigate the inevitable."

Inflation has overshot the Bank of England's 2 per cent target each month since May last year.

Earlier this week, the governor of the BoE, Andrew Bailey, said the bank cannot stop inflation hitting 10 per cent.

sally.hickey@ft.com