Andrew Bailey this afternoon showed that those who start fights don’t necessarily finish them. Speaking as the only witness at the House of Lords Economic Affairs Committee today, the Governor of the Bank of England landed some rather extraordinary accusations against Liz Truss and Kwasi Kwarteng, suggesting that he was not informed of the details in September’s mini-Budget and that he ‘does not think it was settled’ even the day before it was announced.
According to Bailey, both the Monetary Policy Committee and the Treasury officials who were briefing the Bank were forced to speculate about what was coming: ‘There was speculation that this was going to be quite a substantial package,’ he told the Lords committee, ‘but we did not know how big it was going to be and how substantial.’
Bailey’s comments make an already-fried relationship between himself and Truss worse. Right from the outset of the Tory leadership campaign, Truss was pointing the finger at the Bank of England, suggesting it was held responsibility for the inflation spiral that Britain is experiencing. While Truss always stopped short of insisting that the independent Bank raise interest rates, the economists advising her campaign were much more open that a core part of Truss’s economic strategy was to create space for the Bank to tighten monetary policy.
The Governor was also asked whether the Office for Budget Responsibility being sidelined in that mini-Budget process: in response Bailey suggested that the Bank was too. It’s a narrative that Truss and Kwarteng won’t like, not least because it adds to reports that even some of Truss’s closest allies and staff were not aware of the additional tax cuts to be announced, including those who would have played an active role in selling the policies to stakeholders.
But while the politics between the Treasury and the Bank are likely to make the headlines, the far more interesting debate during today’s committee meeting was around monetary policy, between Bailey and the Bank’s former governor Mervyn King, who sat on the panel.
There was no explosion between the two, only polite back and forth. But King has not shied away to point out, on many occasions now, the ways in which he thinks the Bank has got it wrong since the pandemic hit. Just last week King told the Wincott Foundation that ‘central banks really lost touch’ when they broke ‘that intellectual link between inflation and what was actually going on’ within the British economy: ‘It’s true in the Bank of England and the [European Central Bank] that the models they use have the property, that whatever you do to monetary policy, inflation always comes back to the target because it has to. [It’s] the assumption that closes the model.’
‘I certainly wouldn’t want to use [a] model as a basis for making the decisions about monetary policy,’ King followed up. ‘We’ve obviously lost some credibility in what’s happened. There’s no point using models that as soon as you’ve got perfect credibility, that doesn’t make any sense.’
This may read like a technical point, but in the world of monetary policy, there are fighting words. In short, King is hyper-critical of Bailey and the MPC for assuming for well over a year that inflation was ‘transitory’, on the basis of models.
In today’s meeting, nothing so feisty was said, but the undertones were there, with King pressing Bailey on the possibility that a recession was now ‘part and parcel of the process needed to get inflation back… to two per cent on a sustainable basis’. King also suggested that the current base rate of 3 per cent ‘doesn’t seem likely’ to get inflation back down to target,’ which is expected to start falling rather rapidly, according to the Bank’s latest inflation forecast.
Bailey insisted that there was awareness inside the Bank of these points; that its forecast, while showing inflation coming down rapidly in the latter half of 2023, also included ‘the largest upside risk to inflation, in year two certainly’. And in reference to interest rates, Bailey went as far as he could without pre-empting the next MPC vote, saying that ‘the expectation is that there will be more to do.’
This is a particularly interesting response, given the Bank’s last vote to raise interest rates by 0.75 basis points – the first rise of that size in over 30 years – also came with it a strong suggestion in the minutes that it wanted to slow down the pace.
We can’t know if it was King’s questions or a new assessment of the state of the economy over this past month that has led Bailey to pivot away from hinting at a dovish approach. It will be interesting to see over the next few days how market expectations react to Bailey’s latest comments, which suggest a (slightly) more hawkish approach. In the words of the current Governor this afternoon, ‘watch carefully’.
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