WATCH LIVE: BOE Governor Andrew Bailey to speak after rate decision

No, thank you Katie. Well today we've held bank rate at 3.75%. The conflict in the Middle East has significantly affected the outlook for UK inflation. The disruption the conflict has caused to energy supplies has led to a sharp rise in global energy prices. CPI inflation increased to 3.3% in March and is likely to be higher later this year. Monetary policy cannot prevent higher global energy prices from affecting the UK economy and inflation. Our job is to set monetary policy to make sure that the effects of the shock do not become embedded into broad-based inflationary pressures so that inflation falls back to the 2% target and stays there. So, I'll now set out how we expect higher energy prices to affect consumer price inflation before turning to the appropriate monetary policy response and the scenarios that have informed the monetary policy committee's decision today. As I will explain, where we go from here will depend on the size and duration of the shock to energy prices. It's self-driven by how the conflict in the Middle East evolves and how those higher energy prices affect consumer prices in the United Kingdom more broadly. Chart one, which has just come up, shows 12 month inflation in the consumer price index since the start of 2024. That's the blue line alongside our updated expectations for the rest of the year there in the shaded area. Before hostilities broke out in Iran in February, inflation was on track to fall to around the 2% target from April. That's the red line. Recent data releases covering the period immediately before the conflict began suggest this expectation was reasonable. We now project that inflation will rise to a little over three and a half% by the end of the year. This change in the inflation outlook is a direct consequence of the conflict in the Middle East. Chart two shows the scale of the increases in global oil and gas prices. Volatility has been high and the future path of oil and gas prices will depend on how the situation in the Middle East evolves. Uncertainty around any projection of UK inflation is correspondingly high. Higher global oil and gas prices have a direct effect on UK consumer price inflation. Chart three shows how these direct effects have changed the outlook for inflation since February. The prices of fuels moved quickly as global oil prices rose. And higher prices for petrol and diesel have already pushed inflation up relative to our expectations before the conflict, that's the green bars. Household utility bills, that's the orange bars, will follow, and will mostly be affected when OffGEM's next energy price cap for the third quarter takes effect. At this horizon, higher energy costs will also feed through indirectly to consumer prices as firms pass higher costs through their supply chains. That's the purple bars. At first, the indirect effects on the inflation are likely to be largest for food prices since food production and distribution are energy intensive. Further ahead, lower supply and higher prices of fertilizers may also push up on food price inflation through higher costs and lower yields for UK farmers and across the world. There is nothing monetary policy can do to prevent these cost increases from affecting UK businesses and households. The longer the conflict in the Middle East continues, the worse the impact will become. A resolution at the source reopening the Strait of Hormuz and repairing the damage that has been done to the world's energy infrastructure can however reduce the impact of this negative supply shock to our economy. The task for monetary policy is to ensure that as the adjustment to the supply shock happens, inflation returns sustainably to the 2% target. The 2% target applies at all times, but the Monetary Policy Committee's remit recognizes that attempting to bring inflation back to the target too quickly after a shock like this may cause undesirable volatility in output. Monetary policy must manage a trade-off between the speed with which it brings inflation back to target and the consideration that should be placed on the variability of output. Monetary policy generally looks through the direct effect of energy prices on inflation. It takes time for changes in interest rates to affect the economy and inflation. So the direct effects from an energy price shock may disappear from headline inflation before monetary policy can take effect. In that case, higher interest rates would only push inflation below target once the energy price shock had passed, resulting in undesirable volatility in both inflation and activity. Even if the lags in the effects of interest rate changes were shorter, offsetting the direct effect of an energy price shock would require pushing down core inflation by generating additional slack in the economy. Looking through the direct effects of an energy price shock avoids such output volatility as the MPC's remit allows for. The remit also indicates that the MPC should manage a trade-off when considering how much to lean against the indirect effects from an energy price shock on inflation. But because they take longer to come through, the argument for looking through the indirect effects is weaker. Monetary policy can look through some of the inflationary impact from indirect effects to avoid undesirable volatility in output. But protracted indirect effects could keep inflation above target for too long unless monetary policy responds. So by leaning against indirect effects, monetary policy may also reduce the risk that higher inflation becomes embedded through higher inflation expectations and second round effects. Second round effects could arise, for example, if a rise in inflation expectations leads workers to bargain more strongly for wage increases and firms raise wages to maintain real pay for their employees, which in turn would increase their costs and could lead them to set higher prices. Monetary policy should not look through such effects, but the size of any second round effects in addition to the direct and indirect effects is highly uncertain. On the one hand, the larger and more persistent the energy shock is and the more inflation expectations respond to current inflation, the more likely it is that second round effects arise. And inflation expectations have risen sharply in response to the current energy price shock. Repeated high inflation episodes over the past 5 years may have raised people's attentiveness to price increases. On the other hand, the strength of second round effects will depend on conditions in the labor market and the pricing power of firms given the state of the economy. The UK labor market has loosened and that trend has continued in recent months. This suggests that workers will be more cautious in wage bargaining. At the same time, firms may find it difficult to pass on cost increases to their customers given subdued demand. Higher fuel and utility bills will themselves weigh on consumer demand for other goods and services through lower real incomes and weaker consumer sentiment. The uncertainty of the situation is likely to weigh further on firms investment intentions. In addition to being highly uncertain, second round effects build more slowly than direct and indirect effects. That leaves monetary policy with a difficult judgment call because interest rate changes take time to take their effect. Monetary policy cannot wait for conclusive evidence of the strength of second round effects. But responding too early may generate undesirable volatility in output and inflation may drop below the 2% target in the medium term if second round effects turn out to be smaller than anticipated. To inform its policy deliberations, the MPC has considered three scenarios for possible outcomes for the UK economy and inflation over the next three years. These scenarios illustrate that the path for inflation conditional on a market implied path for bank rates in a 15-day window up to the 22nd of April depends crucially on both the size of the energy shock and the extent of second round effects. Chart four illustrates the assumed paths for oil and gas prices in each of the scenarios. In scenario A, oil and gas prices are assumed to follow market futures curves based on the 15-day working day average to the 22nd of April over the next three years. That's the yellow lines. In scenario B, oil and gas prices follow market futures for six months and an average of the futures curve and a constant price thereafter. That's the purple line. This assumption reflects a more cautious view of the duration of the conflict and the time it will take to restore energy supplies through the Strait of Hormuz than implied by current market prices. Scenario C goes further to reflect the risk of a continued substantial disruption to supplies through the strait, pushing oil prices to $130 a barrel and gas prices to 210p per therm and remaining higher than in scenario A and B for the entire projection period. In scenario A, there are no second round effects. In part because the energy shock is relatively short-lived and in part because it is assumed that workers bargaining power and firms pricing power are too weak for such effects to occur given slack in the labor market and subdued demand. Moreover, demand falls disproportionately more than would normally be assumed to reflect weak consumer sentiment after another supply shock. In scenario B, with a more cautious view of how the conflict may play out, the energy price shock is large and persistent enough to lead to modest second round effects under the assumption that workers bargaining and firms pricing powers are only slightly affected by the slack in the economy. Consumption responds broadly in proportion to what would normally be assumed in projections after an energy price shock. In this scenario, scenario C is more severe. The energy price shock is large and very persistent. And I would emphasize here the persistence in this scenario and global supply chain cost pressures intensify. Inflation expectations respond strongly to continued elevated inflation and firms are assumed to have sufficient pricing power for higher wages and costs to feed through more fully to consumer prices, resulting in materially stronger second round effects. Chart five shows the paths of inflation and the output gap. That's a measure of slack in the economy conditional on a market implied path for bank rates based on a 15-day average of forward interest rates to the 22nd of April along with the central projection from February. In scenario A, that's the yellow lines, inflation falls back quickly once direct and indirect effects have fed through. As the energy shock unwinds and energy prices fall again while economic slack persists, inflation falls below the target at the end of next year. In scenario B, energy prices fall back more slowly and CPI inflation remains elevated for longer. Inflation then returns gradually to 2% by the second and third year of the projection, but with spare capacity in the economy. In scenario C, persistently high energy prices and second round effects combine to push inflation above 6% with inflation ending the forecast rise and above the 2% target. A materially tighter policy stance than embodied in the market implied path for bank rate would therefore likely be necessary in scenario C to counter second round effects to ensure that inflation returns sustainably to the 2% target in the medium term. But that is not the case in the other scenarios. As chart six shows, five different illustrative policy rules all point to higher interest rates now than they did in February given the change in energy prices across all scenarios. But the market implied path of bank rate has also moved higher by about 55 basis points measured by the 15-day average of forward interest rates to the 22nd of April compared to the corresponding path to the 26th of January from the February report. Since in February, market pricing was expecting rates to fall by around 40 basis points this year, the chart shows that for scenarios A and B, the illustrative interest rate responses would largely be accommodated by reversing out these assumed cuts without further increasing rates. But this would not be the case in scenario C. Since the end of the 22nd of April, oil prices have risen by more than 20%. Gas prices have risen by 8%. And the market implied path for bank rate has moved higher by up to 35 basis points. But if we think back to early on the 8th of April, we saw similarly sized falls in energy prices and the path of bank rate the day after the announcement of a US Iran ceasefire. This volatility illustrates the unpredictability of the current situation as the markets are trying to assess the implications of the events and commentaries as they unfold. And I would just add for noting that the range on the Brent oil price this morning is over $10 a barrel. So that further illustrates the volatility that we're in. Given the sheer unpredictability and drawing on the evidence from scenario B, there's a good case for holding rates now. But we must recognize that a prolonged spike in energy prices as in scenario C could lead to a higher bank rate while also recognizing that a prompt end to the conflict and a reopening of the strait can take us to the more benign scenario as in scenario A. So let me summarize. The MPC's decision to hold bank rate today is based on two key judgments. First, the continued weakness in activity on the labor market is likely to lessen the strength of second round effects from higher global energy prices. But these effects are likely to be stronger the larger and more persistent is the rising global energy prices. Second, that uncertainty about the strength of second round effects means that monetary policy needs to balance the costs of leaning too little against these effects against the costs of responding too much. The right balance is likely to change depending on how events unfold. The situation remains highly uncertain. We will continue to monitor the situation in the Middle East and how it affects the UK economy and inflation very closely. This includes the size and duration of the energy price shock and its direct effects on UK inflation. It includes the state of the UK economy and how higher costs of energy and other inputs to production pass through to consumer prices. And it includes the potential for second round effects of our wage and price setting drawing on the full range of sources from economic data over surveys of firms and households and intelligence from our agents. I'm sorry that's taken a bit longer than usual but as you can see there are more scenarios and more to explain. So with that Claire, Dave and I will be happy to take your questions. Thank you.

Yeah. So look obviously as the thing about using policy rules is that there are a whole range of policy rules and you can get a whole range of answers. But as the chart I showed a few minutes ago illustrates and bearing in mind this point that there was 55 basis points of cuts assumed before as this set of events started. You know the conclusion from that analysis is that there is a good deal of room to accommodate the type of tightening that would be needed in A or B within that range of 55 basis points. And of course the curve has moved to reflect that. So I can't give you a cast iron assurance that therefore there will be no increase in any scenario or any of those scenarios. But what I can say to you is that there is a good deal of space was available to accommodate that.

Can I make three points on that Marine and Claire may want to come in and the three points are these. First of all, scenario C as I mentioned earlier is a very persistent scenario. So the oil price remains above $100 a barrel through to the end of next year. So that's a key part of scenario C. It's not just where the price is today. That's the first point. Second point is that gas prices don't respond as much as oil prices. The third part is just to reiterate what I said slightly ad libbing a few moments ago. I mean this morning, you know, if we'd had this discussion at, you know, 9:00 this morning, we were looking at a Brent price well over $120 a barrel. Well, I don't know what it is now, but when I walked into the room, it was over $10 a barrel or lower than that. So, that illustrates the volatility of prices. As the MPC, we just cannot stop the music at a particular point in time and say that's it for all time because it is so volatile.

Well, going back to the point I made in response to Marine's question. The sheer volatility of what we're looking at makes it I think very hard to put probabilities on things. This is one of the problems we're dealing with. So, you know, we've been very careful not to put probabilities on these scenarios because it moves around too much. I think the point I would make though and I think reiterate something I said earlier this is very important. The longer this general state goes on the more difficult it becomes. Yeah, I'm afraid that is something we can sort of fairly easily deduce. So look through the volatility. The longer this problem goes on and the longer the disruption to energy supplies goes on, other things equal, it's likely that therefore energy prices will stay higher and the more difficult the scenario we're in.

I'm not going to put numbers on what forceful looks like other than to say I think the point was made very deliberately to say that if we see that type of very difficult scenario emerging, then it's important that we obviously do respond quickly to it. But I don't think it's wise to put numbers on it.

Your question is a very good question. When will we see it? And it goes back to something I said in my opening remarks. The challenge for us, and this is the second round effect point, because judging second rounds is crucial here. Now, of course, the problem is that the second round effects emerge much more slowly and that's in the nature of it really because they're the sort of the follow-on if you like. And it would be a mistake to wait to see the second round effects before acting because then it would be too late. So it's by way of saying it's a judgment that we will have to make at every meeting and this is why I stressed right at the end of my remarks that we will be looking at a very broad range of evidence, some of which will be quantitative but some of which will be qualitative based particularly on what our agents are telling us as to how it is affecting the economy. And I would say from my visits around the country and I'll be out and about tomorrow, we do start in a position where firms very typically say they have been experiencing difficulty in passing costs on. But obviously as this shock is a new feature, that was the sort of the ex-ante state if you like. Obviously they're now faced with an abrupt energy price shock and so we will have to then judge carefully how they both can and do respond to it.

Joel up at the back there and then Sam.

Well, let me turn it in two parts. On the first part, what I did was set out very deliberately a sort of in a sense a sequence of things that you look for. So, you start obviously with the first round effects, which are energy prices themselves. Then we talked about indirect effects, which is how it passes through into the cost of production of other things. And I did put quite an emphasis on food because I think one of the things we learned four years ago was what a considerable share of the cost of final food is energy. Processed food is energy. So that's important. And I also emphasize food because energy and food are the two most salient things in the consumption basket really for people because they're the things we buy most often and most regularly and we can compare prices more easily from time to time therefore. And then you get the second round effect. So those in terms of what will we be watching, those will be the things we'll be watching. On wage setting, wages are set in labor markets. Let me make an important point here. Labor markets at the moment are functioning efficiently. There's no reason in any of the very considerable analysis that our staff do on the labor markets to think that pay is being set inefficiently. Now, it will be some time before we really do get a read on pay and the reason is the seasonal cycle of pay setting because most pay settlements, a large part of the pay settlements, are done in spring. So, we've actually passed through that period for this year.

You're probably immediately going to compare that back to things I said four years ago. And I would just make the following point. Coming out of COVID, the labor market was much less efficient. It was not functioning as well. A lot of work our staff did on job matching was showing there had been a real increase in the inefficiency of the labor market in that sense. But we're not in that place today. Wages will be set in markets.

Sam right there and Josia.

Well, I claim as well on the final point. Let me start on scenario B. One of the reasons that I think there's one element of scenario B that is more plausible than scenario A and that's the energy price profile. And particularly probably the gas price profile because the market curve which is scenario A I think does assume that let's say let's be very optimistic for a moment and say the conflict is over tomorrow. It assumes quite a rapid return to pre-existing supply conditions. Now that's not really consistent with what we hear and I'm sure you hear from people who have looked at the damage for instance that was done to the gas production infrastructure in Qatar for instance where I think the view that we hear is look it is going to take a while to repair that there's some pretty key parts for damage. So scenario B in part is motivated by building that into the assumption.

Did you want to add?

Josia who's right in the middle there, yeah and then Suban.