Andrew Bailey, the governor of the Bank of England (BoE), has insisted that an increase in inflation will be temporary, warning policy makers against overreacting to the jump.
Speaking at Mansion House on Thursday, he said that the rise comes as the UK economy is bouncing back rapidly from the onslaught of the coronavirus pandemic.
“With that has come a rise in inflation, and we expect that rise to continue in the near term as we go through the rest of this year, such that CPI inflation is expected to pick up further above the target, owing primarily to developments in energy and other commodity prices.
“I have set out the reasons why we expect this rise in inflation to be a temporary feature of the bounce-back. The reasons for taking this view are well-founded, it is not a vain hope or a matter of whistling in the wind.”
Inflation has risen above the Bank’s 2% target, with consumer prices increasing 2.1% in the year to May. The members of the Monetary Policy Committee (MPC) expect it to climb above 3% later this year.
Watch: Bank of England expects higher inflation throughout 2021
In his speech, Bailey said that the COVID crisis had created a simultaneous and substantial fall in both demand and supply, but that both in the UK and in a number of other countries, GDP releases during more recent periods of restrictions have “typically surprised to the upside”.
He then went on to say that it was important not to “overreact” to temporarily strong growth and inflation, and that part of the recent increase was due to statistical comparisons with a year ago, during the height of the pandemic.
Those effects “should not last,” he said, adding there’s likely to be a further drop in pricing pressures as further loosening of the rules allows overall consumption in the economy to shift away from goods and toward services.
Despite the recent recovery, the UK economy is still around 5% smaller than it was 18 months ago, before the pandemic struck due to last year’s slump.
However, Bailey said that this was “good news” and that the gap is closing quite rapidly.
Ed Monk, associate director for Personal Investing at Fidelity International, said: “The good news in the messages coming from the Bank of England on inflation is that rate-setters see its current rise as temporary, and seem unlikely to increase borrowing costs just yet to curb it. That’s a relief for borrowers who might otherwise see their monthly repayments rise.
“The less good news is that price rises are likely to continue this year, putting pressure on household budgets.”
His comments come in response to a speech from departing BoE chief economist Andy Haldane, who warned that UK inflation will head towards 4% by the end of the year.
Haldane, who is leaving the BoE to head the Royal Society of Arts, said that inflation could rise by more than expected and force the central bank into a dangerous “handbrake turn” to stop the economy from overheating.
He also warned that heavy use of quantitative easing (QE) risks “an erosion of central bank independence”.
The pound slipped against the dollar on Thursday amid inflationary jitters, down 0.4% to $1.3785.
“The one thing that was propping up the pound in the face of the resurgent COVID pandemic was the expectation the BOE will start normalizing its rates next year,” Credit Agricole’s head of G-10 FX research Valentin Marinov told Bloomberg.
While raising rates between 10 and 25 basis points is still in the cards for next year, “it is unlikely to grow into a tightening cycle in 2023,” he said.
Watch: What is inflation and why is it important?