Interest rates are cut but Bank warns of new inflation shock

Times

3 days ago

The Bank of England is worried about inflation again. Thursday's knife-edge decision to cut interest rates by a narrow 5-4 margin was far closer than markets and most economists expected. It suggests that the threshold for cutting interest rates again this year is getting higher not lower.
More members of the Bank's monetary policy committee are getting squeamish about cutting interest rates when inflation is on course to hit 4 per cent in September — double the Bank's target rate and the highest in two years. September's figure is more important than most for the chancellor as the inflation reading is used to upgrade pensions and benefits at a time when Rachel Reeves is struggling to meet her fiscal rules and will need to find spending savings or tax increases in the autumn budget.
In a double inflationary whammy for the government, this new bout of inflation is a direct cost-of-living pressure as it has come largely from rising food prices. Food price inflation accelerated by 4.5 per cent in June and is expected to hit by 5.5 per cent by the end of the year. Food makes up more than 10 per cent of the UK's consumer price inflation basket.
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When household grocery bills are going up, the Bank thinks the chances of workers asking for bigger pay rises and companies in other sectors jacking up their prices is higher. The Bank says the recent rise in household inflation expectations is being driven 'in part, to the rise in food price inflation combined with households' attentiveness to food prices'.
There are echoes of the 2022-23 price surge, when the Bank and government were flummoxed by the double-digit surge in food price inflation after a series of bad weather events and Russia's invasion of Ukraine caused a global grain shortage.
The combination of an economy that is vulnerable to swings in commodity prices, and the jump in regulated energy and utility prices in April, make the UK a clear inflationary outlier among rich countries. Average consumer price inflation in the eurozone is likely heading below 2 per cent in the coming months, while the US has experienced scant price pressures even in the age of tariffs.
The Bank has no power over global commodity prices but is being forced to keep monetary policy tight even as the labour market slows and the economy is stagnating — worsening cost of living pressures for borrowers and mortgage holders.
The summer's food price surge should prompt the government to take serious measures to protect households from the vagaries of global food and energy prices. There has been plenty of talk about building resilient supply chains since the pandemic, but precious little has been achieved.
British consumers have experienced higher food price inflation than their counterparts in Europe by the order of 1.5 per cent. The Bank also points to the jump in the national living wage in April raising supermarket labour costs and new packaging regulations this year as factors that will put more pressure on food inflation.
The step up in inflation is even more pernicious as it is colliding with a weakening economy, rising unemployment, and a sharp decline in job creation. The jobless rate has hit 4.7 per cent this spring — a four-year high — and could touch 5 per cent next year. Growth figures released next week are also expected to show the economy barely grew in the second quarter.