Truss’s energy bills freeze could curb inflation, says Bank of England

·Finance Reporter, Yahoo Finance UK
·5-min read
Governor of the Bank of England, Andrew Bailey, reacts during the Bank of England's financial stability report news conference, at the Bank of England, London August 4, 2022. Yui Mok/Pool via REUTERS
Governor of the Bank of England, Andrew Bailey, welcomed prime minister Liz Truss's plan to cap energy bills. Photo Yui Mok/Pool via Reuters

The Bank of England has admitted that plans to freeze energy bills by new prime minister Liz Truss could curb surging inflation.

"One of the things that does seem to be under consideration ... is a change to the relationship between gas prices and retail gas prices in a direction that will lower headline inflation, relative to what we were forecasting," Huw Pill, the Bank of England’s chief economist, told the Treasury committee.

Despite inflation pressure resulting from subsidies, "net-net on the implications for headline inflation in the short term, I would expect that to see a decline," he added.

However, Pill, who is also a member of the Monetary Policy Committee, said it was too soon to say what that means for interest rates.

Read more: Liz Truss's energy bills freeze: What does it mean for me?

"I think there's just too much uncertainty to have a strong view right now, given the lack of details."

Inflation is soaring
Inflation is soaring

Governor Andrew Bailey welcomed the plan was more guarded in his comments.

“It’s not for us to comment on what fiscal policy will be and we will wait and see what it is… but I do very much welcome the fact that there will be, as I understand it, announcements this week because I think that will help to in, in a sense, frame policy and that’s important,” he said.

But he did tell MPs he welcomes the prospect of a "clear policy stance" on tackling the surge in the energy bills as markets fret over the country's economy.

“It’s important that there is a clear way forward on policy… That will be important for markets to understand what is going to happen,” he added.

Last month, the BoE issued a dire forecast the UK would enter recession this autumn, with the downturn lasting a year, because of the impact of energy-led inflation on the economy.

Read more: Liz Truss promises tax cuts and action on energy bills in first speech as PM

Confronted by MPs, Pill did not dismiss the Goldman Sachs forecast that inflation in the UK would reach 22%.

Without formally endorsing it, he said it was “plausible”.

Interest rates are climbing as the BoE tackles inflation
Interest rates are climbing as the BoE tackles inflation

The Bank of England, which raised interest rates by 50 basis points to 1.75% last month, is due to make its next rates decision next week.

Bailey hinted that more interest rate rises are on the way by reminding MPs of the threat from inflation.

"We are very concerned that ... people will say this is where inflation is going, and that becomes embedded. There is a very real risk here that [this] will have an effect on inflation expectations and price setting."

Under questioning from committee members, Bailey said that the recent assault on the pound, which has seen sterling hit its lowest level against the dollar for 37 years, was mainly a "dollar story".

Bailey argued that the Federal Reserve has been able to raise interest rates much more sharply, without the same constraint from energy prices that is hurting the UK and Eurozone. "The U. isn't working with the same trade-offs on inflation and activity," he said.

The BoE governor also pointed out that all international currencies were struggling against the world's reserve currency - a traditional safe haven for investors in times of economic stress.

Bailey also said that it is “good” to review that Bank’s remit from time to time, as he prepares to meet with new chancellor Kwasi Kwarteng later this Wednesday.

Read more: Energy crisis: Half of UK small businesses at risk of collapse

“I think it is a good thing to review the remit from time to time, other central banks do that,” he said.

“The Canadians for instance have a formalised review every five years. The Federal Reserve and the ECB (European Central Bank) don’t have a regular schedule, but they do it.

“And actually, there was a plan to do one in early 2020 when I was coming in as governor, which got derailed by COVID.”

Bailey said that the Bank’s role in setting policy was last reviewed nearly a decade ago but defended the central bank's role in tackling inflation.

"The inflation target ... has proved to be very successful. In 25 years since this regime came into existence ... inflation has averaged pretty much exactly on target.

"This is by far the biggest shock we are facing during the life of that, but it is not does not suggest that the regime has failed. What it suggests is that the regime now has to do its work and respond to a much bigger shock and we are confident that it will do so."

However, he added that there are some important elements of the remit. “It’s obviously for the government to choose whether to do a review,” he added.

Last month Kwarteng, who was backing Liz Truss to be prime minister, said that ministers “need to look again at what the mandate is.”

Read more: Liz Truss's energy support package to benefit richer households, IFS warns

In defending the Monetary Policy Committee from criticism of how they've handled inflation, Bailey blamed Russian president Vladimir Putin.

"The person who is going to put this economy into recession is Vladimir Putin and not the MPC," he said.

The Bank of England will take conditions in the gilt market into account when it announces later this month how many government bonds it will sell as part of its quantitative tightening (QT)programme.

"The quantities that will be considered (for quantitative tightening) when it comes to the confirmatory vote next week have taken (market conditions) into account," Pill told MPs.

Watch: How does inflation affect interest rates?