Britain’s messy politics is making it harder for Bank of England Governor Mark Carney to ignore a jump in inflation. The spike in prices is probably temporary and wages remain subdued. But the country’s fragile government will add to bond investors’ nerves.
Carney and his fellow rate-setters are keeping UK policy rates at a record low of 0.25 percent even though prices rose 2.9 percent in May – the highest level in nearly four years and almost a full percentage point above the central bank’s target. That makes sense. While sterling’s weakness after last year’s EU referendum has made imported goods pricier, the effect will fade.
Moreover, inflation is more likely to depress consumption than trigger a self-feeding spiral of rising prices. Average total pay, which includes bonuses, fell 0.4 percent in the three months to April from a year earlier after taking account of inflation, the national statistics office said on Wednesday. It was the biggest drop in British real wages since 2014.
Even so, it is becoming harder for UK rate-setters to do nothing. First, the lack of a clear winner in last week’s elections means fiscal policy is likely to be looser than before. Prime Minister Theresa May’s government is likely to shelve unpopular austerity measures and spend more than previously planned in an attempt to win back disillusioned voters. If politicians are doing more to help the economy, monetary policymakers might feel they can get away with doing less.
Higher public spending does not necessarily mean more growth. Uncertainty over the government’s Brexit negotiations risks hurting business confidence and investment. But there’s another nascent problem brewing in the debt markets. Yields on British government bonds rose sharply after inflation figures were published on Tuesday. Though those moves were reversed the following day and yields remain very low, the move hints at a lurking nervousness.
Purchases of UK assets by foreigners help Britain fund its current account deficit, which was 4.4 percent of GDP last year. If inflation or fiscal worries spur overseas investors to sell gilts, UK borrowing costs could rise and sterling may fall further. That would dwarf any of the challenges facing Carney today.
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