BoE’s Bailey: Path of energy price shock ‘very uncertain’

This is what we call a negative supply shock. In other words, unfortunately, the increase in price of energy products, and particularly obviously imported energy products because we import quite a lot of our energy, is also having and will have a negative effect on activity in the economy. That's most likely. That's a difficult combination. In fact, some might say the most difficult combination of circumstances when inflation goes up and activity is being pushed down.

Now, our remit actually has some very useful language which says we have to balance those two things. Our job is to return obviously the effect of higher energy prices will push inflation up. We've already seen that starting to happen. By the way, the course of this higher energy price shock is very uncertain. It's highly uncertain. But the remit tells us that we have to return inflation to target, to its 2% target. That's critically important and we will do that, but we have some flexibility over balancing these competing, in a sense slightly conflicting, objectives to do that and we will do that. We will do that by in a sense getting the best read we can of how the energy prices are feeding through into the economy and what impact they're having on activity, on the labor market, on employment and so on.

Well, first of all, as you rightly said, duration is important here. So it's not just that we have higher energy prices as we have them in that scenario, it's that we have persistent higher energy prices. So the oil price in that scenario is above 100 dollars a barrel to the end of next year. So this is a long-lived effect. And that's of course the most difficult because that makes it more likely that it will pass through into general inflation. And if we see that happening, if we see this pass through becoming embedded and becoming persistent, we will have to respond because that's our job and it's important because that's how we get inflation back to its target.

Now as you said, the volatility of this situation is another complication. Look at today. I mean already today by middle of the afternoon, we've seen the range on the Brent oil price be over 10 dollars a barrel in one session of trading. And that illustrates just how unpredictable this thing is and how it's moving around based often on what's being said as much as what's being done. So again, that makes our judgments much more difficult in that sense. So again, we're going to have to plot the best course we can through this with uncertainties about what's going on in the Gulf, uncertainties about the level of energy prices but then uncertainties about how it passes through into our economy.

Well, I think that's important. So let's go back to the starting point back sort of end of February. The market was pricing us to cut interest rates somewhere not far off twice, two 25s this year. And that was pretty reasonable because I'd said it previously when we were here a quarter ago, I'd said I thought that was reasonable and not unlikely in my view. So that gives us a starting point with interest rates at a lower point looking forwards. Well, that's come out as it were and that seems to me reasonable. But that gives scope for some tightening in terms of what's expected before we have to actually put today's interest rate up as it were. And that's happened of course.

Now, you made the point that I commented at one point the markets were getting ahead of themselves because at that point, this was going back sometime, it was early March sometime, there was a point when they were expecting four or five increases this year and I said hang on a minute, yes, we've had this adjustment which was obviously a challenging adjustment for markets to make because they were quite heavily positioned for us to cut rates, reasonably so. Sadly, events took over and that's come out but I think we then went too far the other way. So is there a situation where we don't get any rate hikes? Well, we presented the scenarios today and there are a range of territories covered by those scenarios in which I think what we've seen already, which is the taking out of the interest rate cuts that were expected, will actually accommodate seeing off the shock. That's the benign end of things.

If we get the whole thing playing out probably over a shorter time frame, the second round effects as it passes through into general inflation turn out to be smaller because the state of the economy is softer. That is a range of outcomes which that accommodates and then there's another range I'm afraid where we would have to put interest rates up.