The governor of the Bank of England has hit back at critics who accused him of being asleep at the wheel while inflation soared and a cost of living crisis hit UK living standards.
Andrew Bailey said the nature of the shock meant higher interest rates could damage the economy, which recovered slowly from the pandemic during 2021.
Speaking at a conference in Vienna, he said high energy prices would do much of the work to depress consumer spending, allowing the central bank to take a less aggressive approach to raising interest rates.
“What I reject is the argument that in our response to Covid, the Bank’s monetary policy committee [MPC] let demand get out of hand and thus stoked inflation,” he said.
“The facts simply do not support this. On the latest number, UK GDP in March was only 0.6% above its pre-Covid level, and it is substantially below the path it was expected to follow pre-Covid.”
His comments are likely to be interpreted as a notice that the MPC will stop short of increasing interest rates from 2% to 3% in the next year as expected by most City economists.
Bailey, who chairs the MPC, added that while low unemployment and a high level of vacancies were leading to a “tight labour market”, this was not the result of buoyant spending on Britain’s high streets, but rather that the number of people seeking work had dropped.
“What we do have is a very tight labour market. But that does not look like a story about rapid demand growth,” he said.
“The labour force has shrunk by around 1% since the onset of Covid. It looks much more like an impact from the supply of labour.”
About 500,000 people who worked before the pandemic have stopped looking for a job, most of them over the age of 50. Another 500,000 who were expected to emigrate to the UK, mostly from eastern Europe, over the last two to three years have not done so.
The Bank has raised rates four times, from 0.1% to 1%, and is widely expected to increase them at least twice this year to 1.5%.
Bailey’s comments came as the head of the European Central Bank (ECB), Christine Lagarde, said the eurozone’s negative rates would end this year.
Signalling a policy shift to more rapid rate rises, she said the ECB was on track to lift its main policy rate from -0.5% back to zero by the end of September, causing the euro to strengthen against sterling and the US dollar.
Lagarde wrote in a blog that “based on the current outlook” the institution was “likely to be in a position to exit negative interest rates by the end of the third quarter”.
The ECB president is facing growing pressure to accelerate the withdrawal of its ultra-loose monetary policy to tackle record eurozone inflation, though the levels of price increases vary considerably across the 19-member currency bloc.
The governor of the French central bank, François Villeroy de Galhau, said: “If you look at President Lagarde’s statement this morning, the deal is probably done, because there is a growing consensus.”
Speaking on a panel at the World Economic Forum in Davos, Villeroy de Galhau took a tough stand against inflation, arguing that bringing down price growth should be the ECB’s priority.
He said the Russian invasion of Ukraine would have a significant and downward effect on economic growth.
“Less growth and more inflation,” he said. “This is the price we accepted together to pay to protect our values ... It was worth paying this price.”
He added: “I would play down the idea of a short-term trade-off between inflation and growth,” he said. “In the short run, our priority is clearly ... fighting inflation.”
Lagarde’s comments sent the euro up 0.6% against the dollar to $1.0632, while Germany’s 10-year bond yield rose 0.03 percentage points to 0.97 per cent. Bond yields rise when their prices fall.