Bailey: UK energy inflation spillovers still subdued; judgement comes later

Relative to what Bailey warned in late September, this is a more even-handed message, and it may calm some of the aggressive bets on a November rate rise in short-dated gilts and sterling, though it does not entirely exclude one. By singling out Middle East headlines as the dominant influence on gilt yields, Bailey puts oil and gas prices at the centre of Britain's rate outlook: fresh escalation in the Iran war would push energy costs up and reinforce the argument for tightening, while any de-escalation would undermine it. Next on the calendar are the September inflation figures due in the week ahead and the 28 October Budget.

Background:

• BOE, Bailey, Bangkok. What could possibly go wrong? Preview and 3 questions for the Governor

Bailey remains frustrated with inflation but has not been moved to alarm, so November stays on the table even though traders hoping for a rise did not receive the confirmation they wanted.

Summary:

• Second-round effects of high energy prices have been muted to date, in Bailey's assessment.
• He believes it is too early for firm conclusions and says companies are highlighting cost-cutting.
• He described UK inflation sitting above target as enormously frustrating.
• The British economy has been stronger than predicted but not strong enough, he added.
• Gilt yields are most affected by Middle East news, according to Bailey.
• Bank Rate remains 3.75% following September's 6-3 vote to hold, with the next decision due on 5 November.

On Friday, Bank of England Governor Andrew Bailey said the knock-on impact of higher energy prices on UK prices in general has, up to now, been limited; still, he added, forming a firm judgment is premature. This keeps a rate increase possible without flashing any signal that one is about to happen.

At the Institute of International Finance's annual meeting in Bangkok, which is being held alongside the IMF and World Bank annual meetings, Bailey described the evidence on so-called second-round effects as quite subdued. Those effects are the channel through which more expensive energy works its way into wages and into the prices of other goods and services. Businesses, he continued, are emphasising cost-cutting more than they are passing costs on.

Bailey also expressed enormous frustration over UK inflation that remains above target. The economy, he argued, had turned out more resilient than the Bank had anticipated, but remains short of the required strength; Middle East news is the largest force moving UK government bond yields.

These remarks carry weight because the market has piled into bets on a rate rise when the Bank gives its verdict on 5 November. Bank Rate is 3.75%, and the September decision saw the Monetary Policy Committee split 6-3 in favour of holding, with three members wanting to raise at once. Bailey sided with the majority. In late September, though, he had cautioned that sustained high energy costs would make holding rates more difficult, a rhetorical shift that helped drive up the odds of a hike.

Friday's tone is more balanced. Calling second-round effects subdued matches the Bank's September assessment and implies that Bailey has not yet concluded the energy shock is lodging itself in pay and pricing decisions. That is the central question facing the MPC majority. His irritation about inflation, on the other hand, points to limited patience with an extended overshoot, meaning the remarks do not go so far as to oppose a November increase.

The observation on gilt yields underscores how much Britain's interest rate path now rests on oil and gas prices connected to the Iran war. If energy costs move higher again, the case for tightening gets stronger; any relaxation in Middle East tensions would erode it.

Looking ahead, the key signposts are next week's UK September inflation data, the Budget on 28 October, and the Bank's November decision, which will be accompanied by updated forecasts.