The Bank of England is likely to reduce borrowing costs gradually in the coming months, though it will remain “vigilant” for signs of an economic slowdown that could require more decisive action, Bank of England deputy governor Clare Lombardelli said.
Speaking at the Bank of England Watchers Conference in London, Lombardelli noted that although inflation has decreased significantly over the past two years, there are indications that wage growth is cooling more slowly than anticipated, meaning it is “too early” to declare victory on inflation.
Lombardelli pointed out that services inflation remains above its pre-pandemic average, registering at 5% in October. The BoE expects it to remain at that level for at least the next few months, she added.
“We are seeing that wages, rather than profit-seeking, are the material driver of services inflation,” Lombardelli said, explaining that the more persistent nature of services inflation largely reflects the “relatively high ‘stickiness’ of wages compared with other prices.”
In her speech, Lombardelli highlighted that wage rises remain a key concern, particularly as businesses are forecasting pay increases of between 2% and 4% next year, according to data from the Bank’s Decision Maker Panel (DMP) survey. Lombardelli explained that wage growth of around 3% would be consistent with the BoE’s target inflation rate, but any higher increases would complicate efforts to bring inflation under control.
“The slower-moving nature of services inflation reflects, in large part, the relatively high ‘stickiness’ of wages compared with other prices,” Lombardelli said. “Wage growth at this level will make it harder for the Bank to reduce interest rates.”
This comes as Lombardelli acknowledged that the BoE has made good progress in reducing inflation since the shocks that initially pushed prices higher have dissipated. “The UK economy has made good progress on disinflation. The shocks that drove inflation up have dissipated, and inflation has returned to around target,” she said.
However, she warned that there are still concerns about the more persistent components of inflation, particularly in the labour market. “The more persistent components of inflation and uncertainties around how the labour market will evolve are cause for concern,” she added. “So we need careful observation of all the relevant economic data and intelligence as we seek to gradually reduce policy restrictions.”
Some economists believe Britain’s inflation rate could rise back to 3% in early 2025.
Earlier this week, another BoE deputy governor, Dave Ramsden, suggested that UK inflation could undershoot the BoE’s latest forecasts, potentially requiring more aggressive rate cuts.
Lombardelli said that early reports from the purchasing managers’ index (PMI) for November showed signs of a slowdown in the UK economy. However, she was careful not to take any strong signals from a single data release, stating the importance of continuing to monitor a broad range of economic indicators.
The Bank’s deputy governor also said it’s “uncertain” what impact the increase in employer national insurance contributions will have.
She said: “We are hampered by the challenges of the quality of data, in particular in the Labour Force Survey.”
“There have also been recent changes to the costs of employment from the combination of the increase in the National Living Wage, the rise in employer National Insurance Contributions, and potentially the changes to workers’ rights. Although the size, timing, and interaction of these effects are uncertain.”
On the national insurance contributions increase for employers, Lombardelli also said: “It’s a big policy change, and it’ll have a large impact. Exactly what that impact will be is uncertain.”
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She added that the “early conversations” Threadneedle Street had been having with companies showed “quite a range of proposed responses,” depending on the size of the firm and the sector it was operating in.
Since August, the Bank of England has already reduced its key interest rate twice, bringing it down from 5.25% to 4.75%. However, the pace of rate cuts has been more cautious compared with the European Central Bank and the US Federal Reserve, largely due to concerns about inflationary pressures in the UK jobs market.
Fellow rate-setter Swati Dhingra warned that Donald Trump’s plan to impose massive tariffs on Chinese goods could drive down global prices, potentially leading to lower inflation worldwide.
Speaking at the same event, Dhingra said that a second Trump presidency, with a proposed 60% tariff on Beijing, might prompt Chinese exporters to reduce their prices to maintain trade volumes with the US.
Dhingra explained that a significant tariff increase would have a major disinflationary effect on the global economy, particularly as Chinese exporters adjusted to maintain their market share.
“It takes a massive amount of demand out of the world market. The way exporters, say in China, would respond to that would be to respond with prices, world prices, as they don’t want to lose market share,” she said.
President-elect Trump said he would impose tariffs of up to 60% on Chinese goods and up to 20% on other US trade partners. Dhingra noted that while there is still uncertainty about which policies Trump would actually implement, such a drastic tariff could have significant consequences for global inflation.
“If there is the kind of big 60% type of tariff increase that’s been proposed, that will have repercussions on world prices, and mostly in the downward direction,” Dhingra said, adding that this could lead to lower prices globally, including in the UK.
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However, she also cautioned that if other countries retaliated with tariffs of their own—resulting in a broader “tit-for-tat” trade war—then the situation could change dramatically. In that case, Dhingra said, the disinflationary effect might not materialise, and inflationary pressures could rise instead.
Drawing a comparison with Brexit, Dhingra said that the UK’s departure from the European Union had caused a permanent increase in the cost of goods for UK households. While this led to short-term inflationary pressures, she noted that the longer-term effect had been different.
“We saw much higher price increases in the UK compared to everywhere else, and those pressures have now come off much more quickly as well for the reason they’re not inflationary, they change the price levels, permanently,” she explained. “It’s a shift in the price level rather than an ongoing inflationary impact.”
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