The announcement from the Office for National Statistics (ONS) that inflation has risen above the Bank of England’s 2 per cent target for the first time this year, hitting 2.2 per cent, may seem alarming at first glance. With some commentators suggesting economic disaster looms and claiming that the UK economy is on the brink of collapse, it’s easy to feel concerned. However, the reality is that there’s no immediate cause for panic.
While the rise in inflation is not ideal for the Bank of England, it’s important to understand that the Monetary Policy Committee (MPC) is not to blame. The last two years have seen inflationary pressures spiral out of control, largely due to the MPC’s failure to react swiftly enough. Initially, the committee disregarded the warning signs, allowing inflation to surge and pushing millions of households deeper into poverty. In a bid to regain credibility, it raised interest rates too aggressively and kept them elevated for far too long, likely causing considerable damage to the UK economy. The full consequences of these decisions will become clearer over the next few months and years.
The Bank of England has recently made the right decision by starting to reduce interest rates. Some have raised concerns that these cuts may have contributed to the uptick in inflation, but this is not the case. The data released pertains to the previous month, meaning any effects from the Bank’s monetary policy changes would not yet be visible. In addition, monetary policy tends to have a lagged effect, so the consequences of rate cuts will not be felt for several more months.
Even though the MPC is not responsible for the current rise in inflation, the question remains: did it make a mistake by cutting rates while inflation is above target? Again, the answer is no. A slight increase in inflation was anticipated, due to the base effects of energy prices falling less sharply than last year. In fact, inflation rose by less than expected, and core inflation, which excludes volatile food and energy prices, actually fell more than anticipated. These are positive signs.
Moreover, two key issues that had been concerning the MPC—services inflation and wage growth—are showing signs of improvement. Services inflation, which had remained persistently high in recent months, has now dropped more than expected. Similarly, wage growth has slowed to its lowest point in two years, which is a welcome development for controlling inflation.
Despite inflation being slightly above target, these signs indicate that inflation is unlikely to spiral out of control again. In fact, the real concern now is the possibility of inflation falling below the Bank’s 2 per cent target, which could signal a lack of demand in the economy. This is far more worrying than a minor uptick in inflation, as it suggests that households will spend less, and businesses will be reluctant to invest. The result could be a slowdown in economic activity, with fewer new businesses, a reduction in profits, and fewer job opportunities. This, in turn, would exacerbate the UK’s already low productivity levels and stagnant economic growth.
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If inflation were to fall too far below target, it could lead to a recession, with widespread consequences for ordinary people, particularly the young and the most vulnerable. This would undoubtedly cause significant hardship, making it essential for policymakers to address this potential threat before it materialises.
To prevent this, the Bank of England must resist any calls to reverse its recent decisions on monetary policy. Reversing course would likely do more harm than good. Instead, the Bank should consider accelerating interest rate cuts. At the next MPC meeting in September, it would be prudent to reduce the Bank Rate to 4 per cent, aligning it more closely with real interest rates. This would help to provide the necessary stimulus to the economy while mitigating the risk of a deeper downturn.
While the Bank of England has made some mistakes in recent years, it is not to blame for the recent rise in inflation. This increase should not be a cause for concern. Instead, the real danger lies in inflation falling too far below target, which could stifle economic growth and plunge the country into recession. It is imperative that the MPC acts decisively to prevent this from happening.
