Interest rate rises likely despite energy bill freeze says Bank of England

The Bank of England’s chief economist said on Wednesday that plans by Liz Truss for a freeze in energy bills for households and businesses was likely to force the central bank to raise interest rates despite bringing down the rate of inflation in the months ahead.

Asked by MPs on the House of Commons Treasury select committee specifically about whether the package would mean higher interest rates, Huw Pill said: “In response to the question, will fiscal policies generate inflation — we are here to ensure that they don’t generate inflation . . . Our remit is to get inflation back to target.” 

“We do have work to do,” he added.

The comments by Pill, who was appearing alongside governor Andrew Bailey and two other Monetary Policy Committee members, came after they were repeatedly asked by MPs to comment on the new UK prime minister’s expected £150bn-plus rescue package that will be met by government borrowing.

Bailey declined to comment specifically on the expected bailout explaining that the government had yet to announce the measures, which Truss confirmed she would outline on Thursday. But he added: “We have to take the actions we have to take to hit the inflation target, hard as though those may be in terms of the consequences,” explaining the bank’s focus was on bringing inflation back down to its 2 per cent target.

Pill told the committee that the energy crisis was hitting households hard. “High gas prices have an income implication for the UK,” adding that if the pain was absorbed by increased public borrowing it would have two effects on inflation.

In the coming months, the effect of freezing energy bills would probably stop inflation rising much further this autumn from the 10.1 per cent level it reached in July, he said. “This will lower headline inflation relative to what we were forecasting in our August report.”

But he added that interest rates did not depend on price movements in the weeks ahead. “That very short term implication on inflation may not be the most important thing for the monetary policy point of view. For the monetary policy point of view it is what is the implication of the package of measures . . . for inflation at longer horizons,” Pill said.

He added that the likely result of freezing energy bills and cutting taxes would be to raise spending in the economy and this would “probably lead to slightly stronger inflation”. 

When asked whether a recession was necessary, all four of the BoE officials blamed Russian president Vladimir Putin’s invasion of Ukraine and his decision to cut off gas supplies to western Europe for the downturn they expect this winter in the UK.

Bailey, however, accepted that the MPC had not tried to offset a recession by lowering interest rates in August because his job was to worry about prices.

There were some differences of view among the BoE officials about how fast interest rates needed to rise to offset the inflationary threat. Catherine Mann, one of the external MPC members, said faster rate rises would help to lower inflation expectations, which she said had already risen too far.

Another external MPC member, Silvana Tenreyro, however, said that even if the BoE had held interest rates at 1.25 per cent in August rather than raising them to 1.75 per cent, that was likely to be enough to bring inflation back to target in the medium term.

She has been in a minority of one on the committee in urging caution and added that raising interest rates was best to be done “slowly when there is a lot of uncertainty”.