"Blunt" Pill says More Hikes Needed

Above: File image of Huw Pill. Image © Pound Sterling Live. Stll source: Youtube, Goldman Sachs.

The Bank of England's Chief Economist says he stands ready to vote for a faster rate of interest rate hikes, should he see further signs inflation is becoming embedded in the UK.

In a speech delivered at Kings College and the Qatar Centre Huw Pill said his and the Monetary Policy Committee's focus remains on returning inflation to its 2% target via hiking interest rates .

"It is time for plain speaking," said Pill. "I want to speak – at least for a moment - more directly, more simply, perhaps more bluntly... I see my role as an MPC member as being ‘in the price stability business."

He said the case for an accelerated pace of interest rate hikes would become clear if incoming data suggested firms were intent on hiking prices and workers were proving successful in bargaining higher wages.

And the contents and emphasis of the speech suggest this is indeed something he is concerned about.

"UK inflation is high both because of the direct and indirect impact of higher international energy and goods prices and because of the impetus to domestic inflation imparted by the strength of wage growth and corporate efforts to re-establish profit margins," said Pill.

He warned that inflation risks becoming embedded as higher energy prices lead to 'secondary effects' in the form of higher wage demands and corporates hiking prices.

"UK price setters and wage bargainers will try to offset the impact of higher headline inflation on their real spending power by seeking higher profit margins or higher wages in order to preserve their real income," says Pill.

"Crucially, this threatens to create more persistent inflation dynamics in the UK," he adds.

Above: Market implied expectations for Bank Rate. Image courtesy of Goldman Sachs.

It is via such second-round effects that higher current inflation can become embedded in the inflation process and achieve a self-sustaining momentum all of its own, and this therefore requires the Bank to act via higher rates.

"Because the inflationary implications of second-round effects are more persistent, they are more relevant to the pursuit of the inflation target over the medium term," he said.

However Pill would not address the scale of the hike he saw fit at the next MPC meeting in August but his emphasis on the dangers of inflation becoming embedded would suggest he wants to get a move on.

He said the Bank had decided to ditch its Forward Guidance that "further tightening" would be warranted as it had become outdated for a central bank that was now clearly in a hiking cycle.

Instead the Bank wants emphasis that it was prepared to act based on incoming data.

This he said would condition the markets to become more cognitive of the economy's performance when assessing where interest rates might be headed, as opposed to assuming the Bank was on auto pilot.

The Bank of England's Jon Cunliffe has also spoken today, raising the prospects for an unusually large 50 basis point interest rate hike in August by promising action will be taken to control inflation expectations.

In an interview with the BBC on Wednesday the Deputy Governor of the Bank said the Monetary Policy Committee will ensure that the recent surge in inflation does not become embedded in the economy.

"It's our job to make sure that as this inflationary shock passes through the economy we don't find that leaves us with inflation being the new normal, the sort of embedded psychology," he said.

"We will act to make sure that doesn't happen," he added.

The promise of action underscores market pricing for a 50bp hike in August as the central bank seeks to ensure inflation does not accelerate.

The UK saw inflation reach 9.1% in May and the Bank of England's June update showed forecasts for a peak near 11% in October.

The Bank said at the time of June's update - where it raises rates by a further 25 basis points. - that it would act "forcefully" if it saw signs of inflationary pressures becoming more persistent.

"We think a 50bps hike by the Bank of England (BoE) is now more likely than not in August," says Christopher Graham, European Economist at Standard Chartered.

Analysts say the 75 basis point hike at the Fed in June will keep the pressure on other central banks, such as the Bank of England, to rapidly raise interest rates.

Standard Chartered also says market current market pricing (45bp currently priced in for August) and slightly better-than-expected economic data releases (June PMIs, May retail sales) means a larger hike in August is now their base case.

But Graham says a 50bp move will likely be a one-off event which would disappoint market expectations for two such hikes by November.

"We think September’s meeting will be a close call, but on balance still see a 25bps hike. However, this view is predicated on our expectation that headline growth data will show further signs of slowdown by then and labour-market data will begin to show signs of inflecting," says Graham.

He says any upside surprises on either the labour-market front or in inflation expectations could prompt another 50bp hike by the Bank.