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20 July 2023

The Bank of England has lots more pain to inflict

Inflation is rising less fast than expected – but that may not be much help.

By Will Dunn

Readers who have attempted to move a grand piano sideways across an ice rink will know how policymakers at the Bank of England felt yesterday (19 July): you scrabble at the ice, slipping and falling, desperately trying to overcome the friction of the mass in front of you. It seems as if nothing is happening – and then, with a jolt, it begins to move.

Economists had predicted that inflation would fall, but not by as much as it did. The consensus was that the consumer prices index would fall from 8.7 per cent to 8.2 per cent; in fact it dipped to 7.9 per cent. This comes as a relief because it means prices are rising less quickly (although they are still rising fast), but also because it means the Bank is less likely to impose another hulking half-point rate hike on the mortgage holders and businesses already struggling to cope with more expensive debt.

It’s now widely assumed that the Bank will raise the base by 25 basis points to 5.25 per cent at the next Monetary Policy Committee (MPC) announcement on 3 August, although members could vote to pause rate hikes, as the US Federal Reserve did last month. Better still, market expectations are that interest rates will peak below 6 per cent.

However, the headline inflation rate is not the most important number that will be discussed. That distinction may go to this measure of pay growth, which states that the wages of regular workers (the 30 million people in the UK who are paid through PAYE) rose by 9.7 per cent in the year to June.

Workers may congratulate themselves that rising real wages are back, baby, and it’s time to party like it’s 2005, because with pay going up 1.8 per cent faster that prices, things are generally becoming more affordable.

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[See also: Is the Bank of England raising interest rates too far?]

The problem, however, is that this growth in pay isn’t happening because UK PLC is smashing its targets, but because there are lots of unfilled vacancies at UK PLC, which is causing managers to spend more to hire or retain staff. The Bank’s remit is to use its policy to prevent this from developing into more inflation (if people are paid more, they spend more, and prices follow). Torsten Bell, director of the Resolution Foundation, says the “exam question” currently being answered by the MPC is: “Do loads more of us need to lose our jobs, before we stop asking for decent pay rises?”

The Office for National Statistics’ Labour Force Survey data does show this happening: in March to May, the number of people who were unemployed for less than a year increased by 63,000. But that doesn’t mean it will stop increasing just yet; wages are still rising and less than half of the impact of rate hikes has been felt by mortgage holders.

The big question for jobs, mortgages and everything else is not how high interest rates will peak but how long the higher-rate period will last – and whether it could actually be permanent.

As the Resolution Foundation pointed out in a report published on Monday (17 July), we are heading towards an inflection point. The ultra-low rates of the post-2008 era helped swell household wealth in the UK to almost eight times GDP, which might sound good, but mostly what it means is that property became overvalued and a generation was priced out of owning homes. The return to higher interest rates has knocked £2.1trn off the UK’s total household wealth in the last year, which might sound bad – but if it persists it will mean more affordable housing for millions of people.

In the years to come we will find out if higher rates are a bump or a plateau. If it’s the former, home ownership will continue to be mostly a matter of inheritance and the housing crisis will effectively be permanent; if the latter, a lot of people who thought their houses could replace their pensions will have poorer retirements. Each scenario is bad for one demographic, and the transition could be uncomfortable for everyone. There is, says Bell, “lots of pain still to come”.

This piece first appeared in the Morning Call newsletter; subscribe to it on Substack here.

[See also: Is anybody running the Bank of England?]

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