A key ritual in the quarter-of-a-century since the Bank of England gained its independence is the requirement that the Governor writes to the Chancellor with his excuses when the inflation target is missed.
The Chancellor responds, and both letters are released with minutes of the Bank’s deliberations.
Amid all the excitements about the runaway inflation projection (now up to 11 per cent) and the impact of interest rate rises on servicing mortgages and corporate debt, the nuance of responses from the Chancellor could easily be missed.
Concern: Bank independence prevents Chancellor Rishi Sunak from dictating to the Monetary Policy Committee
Rishi Sunak plainly is fearful. As the person in charge of the nation’s finances he does not want to see interest rates zipping up. Rising borrowing costs have a dramatic impact on the cost of servicing the national debt mountain.
Significantly, Sunak recognises that although much of the cost of living surge is down to post-pandemic energy bottlenecks and Russia’s war on Ukraine there are aspects that need to be better handled.
His June letter to Bank Governor Andrew Bailey and the interest rate-setting Monetary Policy Committee (MPC) includes firm words. Not least Sunak points out that it is ‘imperative to bring inflation down to target’ of 2 per cent.
The Chancellor is less than impressed by those economists, including former US Treasury Secretary Larry Summers, who argued that there was no risk in allowing borrowing and debt to balloon.
They argued that inflation was well anchored and interest rates at record low levels are likely to remain there.
How quickly that has changed. As Sunak points out in his latest letter to Bailey, he is particularly concerned that rising prices do not become persistent.
Worries about the potential of a wage price spiral are among the reasons why the Government is closely watching negotiations between the train firms (several of which are in the public sector) and the Rail, Maritime and Transport Workers (RMT) union.
Aside from the potential disruption to national output the Government is of the view that public sector employees are relatively well remunerated and it doesn’t want to see future inflation predictions built into wage deals.
Bank independence prevents the Chancellor from dictating to the MPC in his letter. The tone is firm, with Sunak emphasising the importance of decisive action by the committee. The Bank would argue that it has done just that, with five consecutive quarter-point increases in rates.
Nevertheless, the MPC would be wise to find its inner-Volcker (the thoughts of the former chairman of the Federal Reserve, the US central bank). He argued that rises in borrowing costs have to be convincing enough for consumers and businesses to be persuaded to constrain behaviour.
The Fed’s three-quarter of a percentage point rise in rates to a range of 1.5 per cent to 1.75 per cent might not have carried them to a much higher level than on Threadneedle Street.
But it showed a degree of sabre rattling and decisiveness absent at the Bank. The Fed’s decision to lift its interest rate projection for 2024 to 3.8pc, a full point higher than previously projected, suggests chairman Jay Powell has learnt from Volcker.
What is striking about the MPC minutes is the unity of the Bank insiders (most of whom have worked at HM Treasury) against the dissent of three outside members, who wanted something bolder.
Former Bank of England governors are normally circumspect in public comment on their successors. But Mervyn King, who established the Bank as a dependable inflation-fighting machine, provided a corrective in an off-piste Spectator diary item.
King writes that, with inflation running away, it was time to ‘have a word’ with those MPC members, including Bailey, who in 2021 were keen on negative interest rates.
The former governor, a highly regarded academic economist, noted that inflation is spreading beyond energy, where it began, to most of the economy.
Bank independence means that Andrew Bailey is safe from dismissal. Indeed, he is only in the foothills of an eight-year single term. The rest of the MPC has less protection and over time could be shaken up.
Most importantly, the Chancellor has what the Americans call a ‘bully pulpit’ in the shape of his letters to the Governor.
After the Bank’s poor calls of the last year he is showing intent to make use of it.
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