By David Milliken and Phoebe Seers
LONDON, April 1 (Reuters) – Bank of England Governor Andrew Bailey said on Wednesday that markets were still getting ahead of themselves by pricing in interest rate hikes by the central bank, which wanted to avoid adding to the damage Britain’s economy will face from the Iran war.
Bailey, speaking to Reuters at the central bank’s London headquarters, said BoE policymakers would need to keep a clear focus on risks to growth and jobs as well as inflation when making their next decision on rates.
The war in the Middle East has driven up energy prices sharply, fuelling inflation but also dealing a wider blow to the global economy.
“We will have to, obviously, act on monetary policy if we think it’s appropriate to do so. But it strikes me, and it still strikes me today, that the most important thing to do is to tackle the source of the shock,” Bailey said in the interview.
“Of course, we have to deal with the shocks that come our way. But our remit is very clear on this that … we have to do so in a way that … causes the least damage in terms of activity in the economy and in terms of jobs,” he added.
MARKETS ‘GETTING AHEAD OF THEMSELVES’
Financial markets are currently pricing in two rate hikes by the BoE this year – and have previously priced in as many as four – while most economists polled by Reuters expect rates to stay on hold.
“(The market)’s still pricing us to raise rates. I would still say that is a judgment markets have to make but I think they’re getting ahead of themselves,” Bailey said.
While the BoE voted unanimously to keep interest rates on hold at 3.75% last month, Bailey has been the swing voter on the Monetary Policy Committee in previous meetings.
Some members have talked about a possible need to raise rates to stave off inflation threats but Bailey said a precautionary rate rise might not be in line with his view of how the BoE should implement its remit to keep inflation at 2% over the medium term.
“I’m sure that will be debated in the MPC, it would be appropriate to do so. But we have got to judge that in the context of the way our remit is constructed,” he said.
Bailey approvingly cited comments made during a jump in inflation in 2011 by then-BoE Governor Mervyn King, who said it was the BoE’s job to discharge its remit in a way that causes the least damage to the economy and the people.
The MPC next meets to set interest rates on April 30.
BUSINESSES LACK PRICING POWER, BAILEY SAYS
Before the crisis, British inflation was on course to fall back to its 2% target and the BoE had said cutting rates further was likely. That changed dramatically with the start of the Iran war, a shift that Bailey said was “intensely frustrating”.
Bailey said the BoE was looking at a sharp rise in households’ inflation expectations last month “very carefully” but said they often reflected moves in headline inflation and that the message he had received from businesses was that they had limited ability to raise prices.
“Businesses consistently say to me that they’re operating in a context of an absence of pricing power,” he said.
Britain’s economy is considered to be particularly exposed to the inflationary impact of the rise in global energy prices, due in large part to its heavy reliance on natural gas to generate electricity and heat homes.
Bailey said some pass-through of higher energy costs by businesses was likely, but the overall climate was one of economic weakness, in contrast to 2022 when energy prices surged due to Russia’s full-scale invasion of Ukraine.
“The context at the moment is of a softening labour market. We think activity is bit below potential – so a bit of an output gap is opening up,” he said.
The BoE said last month that it expected inflation to hit 3.5% in the third quarter of 2026, almost double its 2% target but well below a peak of 11.1% in October 2022.
(Additional reporting by Andy Bruce and Suban Abdulla; Writing by David Milliken; Editing by William Schomberg and Toby Chopra)
