UK borrowers can expect to face higher interest rates as a result of the Truss government’s tax and spending decisions during its six weeks in power, the governor of the Bank of England has warned.
Despite the U-turn on corporation tax on Friday that saw the sacking of Kwasi Kwarteng as chancellor, Andrew Bailey said the extra stimulus provided in last month’s mini-budget would add to inflation and force the Bank into tougher-than-expected action.
Bailey said he had impressed on the new chancellor, Jeremy Hunt, the need for the public finances to be sustainable and that there had been a “clear and immediate meeting of minds”. Hunt used his first interview to stress mistakes made by Truss would require “difficult decisions” to be made.
The governor said it was not for him to “constrain the choices” Hunt will make in his fiscal statement on 31 October, and said the decision to go ahead with the planned increase in corporation tax was “important”.
Even so, Bailey made clear that tough action from the Bank on borrowing costs could be expected in early November.
He said Russia’s invasion of Ukraine had resulted in the UK being hit by a bigger shock than during the oil crises of the 1970s, and the government’s decision to protect households and businesses with a price cap was “understandable”.
But the governor added: “The price cap will add to demand relative to what it would have been without the cap, and thus what we thought in August. It will therefore add to inflationary pressures towards the later part of the two-year period on which we focus.
“More recently, the UK government has made a number of fiscal announcements, and has set 31 October as the date for a further fiscal statement. The monetary policy committee (MPC) will respond to all this news at its next meeting in just under three weeks from now. This is the correct sequence in my view. We will know the full scope of fiscal policy by then. But I will repeat what we have said already. We will not hesitate to raise interest rates to meet the inflation target.”
The Bank raised interest rates by half a percentage point to 2.25% last month, and Bailey’s comments will heighten speculation of an increase of 0.75 or 1.00 percentage points in November.
Bailey was critical of the Truss government’s decision not to have the September mini-budget scrutinised by the independent Office for Budget Responsibility and said he was pleased the 31 October statement would be accompanied by a report from the watchdog. “Flying blind is not the way to have fiscal sustainability,” he said.
Mortgage rates have risen sharply as a result of the adverse market response to the government’s mini-budget, leading to a sharp drop in housebuying activity.
Bailey hinted that the Bank of England would be wary of stepping if there is fresh turbulence when the financial markets reopen on Monday.
Threadneedle Street acted to halt a run on pension funds after the mini-budget but Bailey said the “interventions are strictly temporary, and have been designed to do the minimum necessary”.
He added: “Our financial stability operation was very much a short-term one. It ended yesterday after only two weeks of operation.”
The Bank’s actions were to ensure financial stability rather than about steering market interest rates to any particular level, he said.