Say what you like about the Bank of England but its timing is impeccable. Just as the Tory leadership race reached its “It’s the Economy, Stupid” phase, the Bank has not only raised interest rates by 0.5 percentage points, the most in more than a quarter of a century, but has also proved that it is Taking Things Seriously by issuing an unusually dire set of warnings about the coming months.
Central banks are not known for their excitable language because they want to avoid spooking skittish markets, so the phrasing in the release that accompanied the interest rate rise raised eyebrows. The Bank said that inflation would rise to 13 per cent – its highest since the early 1980s – before the end of the year, and remain at “very elevated levels throughout much of 2023”. It also warned of a recession beginning in the fourth quarter of this year and lasting about a year. In central banking terms, Andrew Bailey, the Bank’s governor, may as well have been pointing at the sky and shouting about the arrival of four horses.
The statement sends a message to markets that the Bank has completely banished all notions of transitory inflation – the idea that high price rises were a fleeting effect of the pandemic – and is ready to get tough. This toughness is particularly conveniently timed, after criticisms of how slowly it has moved to tackle inflation from both Conservative leadership candidates but Liz Truss in particular, who vowed at a hustings in Wales to change the Bank of England’s mandate “to make sure in the future it matches some of the most effective central banks in the world at controlling inflation”.
The suggestion was that she may remove the Bank’s independence, which was given to it by Gordon Brown in 1997 and is generally regarded as one of his more successful moves. Truss disagrees. “Things are very, very different now,” she said.
Her enthusiasm to seize control ignores the increasingly clear fact that the Bank of England – or the chancellor, if Truss’s wishes come true – has only limited power to bring down inflation such as we are currently experiencing. The biggest contributing factors to price rises, according to the Office for National Statistics, are motor fuels (pushed up by the war in Ukraine), transport (largely powered by motor fuels, which have been pushed up by the war in Ukraine), and food prices (the cost of producing which has been pushed up by – you guessed it – the war in Ukraine).
Although there are some elements the Bank does have control over, such as wage rises (increasing the cost of borrowing by raising interest rates means companies won’t have the cash to raise salaries, so people don’t have as much disposable income, which should drive down demand), the effect even the recent hefty rise will have is limited. That’s awkward for Truss and Rishi Sunak, her opponent, who will want to look like they can seize control – because no matter who wins the leadership election, the coming months are likely to be very difficult for households.