Bank of England governor Andrew Bailey has said he is “monitoring developments” and will “not hesitate” on interest rates as the central bank grapples with a volatile currency market in the wake of last week’s mini-budget.
It comes after sterling plunged to a near 50-year low against a basket of currencies including the dollar, against which it remains close to record lows.
Sterling was trading close to $1.03 – its lowest level against the dollar since Britain went decimal in 1971 – early in the Asian session before gaining some ground when the domestic market opened. By 5pm it stood at $1.07, meaning that since the start of 2022 the pound is down 20% against the dollar.
Tom Stevenson, investment director for personal investing at Fidelity International, said the “radical” mini-budget last week had “raised more questions than it answered”, particularly over who would pay for the tax giveaways.
Bailey welcomed the government’s “commitment to sustainable economic growth” and noted “the role of the Office for Budget Responsibility in its assessment of prospects for the economy and public finances”.
He noted that the government has made a number of announcements in recent weeks, including the energy price guarantee, which is hoped will reduce the near-term peak in inflation.
But it is last week’s growth plan that has caused turmoil in markets. On this, Bailey said that the Monetary Policy Committee (MPC) would ensure that demand would not get ahead of supply in a way that leads to more inflation in the medium term.
“As the MPC has made clear, it will make a full assessment at its next scheduled meeting of the impact on demand and inflation from the government’s announcements, and the fall in sterling, and act accordingly,” he said.
“The MPC will not hesitate to change interest rates as necessary to return inflation to the 2% target sustainably in the medium term, in line with its remit.”
George Lagarias, chief economist at Mazars, said: “After last week’s transformational budget, it was a given that the Bank of England would be compelled to review its stance on interest rates, with a view to accelerating hikes.”
While the mini-budget may not in and of itself cause inflation, it is the market reaction that has concerned the policy makers as the weaker currency will make for costlier imports.
“While central banks seldom accept that they would intervene to support their currencies, currency weakness is inherently inflationary for economies with trade deficits. We believe it is natural for the Bank of England to seek a more hawkish path and would not be surprised if this is announced at the next meeting,” Lagarias said.