Andrew Bailey has admitted for the first time that the UK is fighting a wage-price spiral, in a sign the Bank of England is increasingly concerned the country faces a protracted crisis.
The central bank governor told business leaders in London that even as the initial shocks from the energy crisis were wearing off and headline inflation would likely fall, “second round effects” were unlikely “to go away as quickly as they appeared”.
Threadneedle Street officials have consistently said that the Bank was raising interest rates to avoid high inflation becoming entrenched in the wider economy through wages and prices.
Mr Bailey acknowledging that such second-round effects are rippling through the UK means that the Bank failed to keep a lid on domestically generated inflation.
It comes as data released on Tuesday showed that private sector wages grew by 7pc in the three months to March, far higher than is consistent with the Bank’s 2pc inflation target.
He said: “Some of the strength in core inflation reflects the indirect effects of higher energy prices. But it also reflects second-round effects as the external shocks we have seen interact with the state of the domestic economy.”
The warning also suggests that inflation could take much longer to fall than initially expected, meaning interest rates would have to stay higher for longer.
Mr Bailey said: “While we expect CPI inflation to fall quite sharply as energy costs begin to ease, albeit at a somewhat slower pace than projected in February given the near-term outlook for food prices, the outlook for inflation further out is more uncertain and depends on the extent of persistence in wage and price setting.”
He said that while there were signs of the labour market starting to loosen, it was happening more slowly than the Bank had predicted only months ago.
The job market still remains very tight, he added. Vacancies are also still very high despite coming down marginally, which adds to inflation as employers have to compete harder for workers by raising salaries.
The Bank has already raised interest rates 12 times to 4.5pc. Mr Bailey said policymakers would have to lift borrowing costs further “if there were to be evidence of more persistent pressures”.
He added that “near-term indicators suggest that pay growth could ease further later this year”, however.
Mr Bailey also defended the Bank’s record on inflation again, saying Threadneedle Street would have had to raise interest rates well into double digits during the pandemic if it had perfect foresight. This would have pushed up unemployment substantially and carried massive risks.
“Monetary policy can’t make the impact on real incomes go away I’m afraid,” he said.
He added: “I’d like to push back strongly against one argument you sometimes hear, which is that inflation is high because monetary policy was too loose in the past.”
The Bank of England has faced growing criticism for its failure to stem inflation, which has remained in double digits for eight months in the past year.
Several economists have claimed that the Bank’s quantitative easing programme during the pandemic - which saw it buy bonds largely from the government – likely added to rapid consumer price growth.
Mr Bailey acknowledged that the Bank was facing the “biggest test” of its inflation-targeting regime, with prices in recent months rising at the fastest pace in around 40 years.
Inflation in the UK was at 10.1pc in March. Mr Bailey said he expected it to fall by around one percentage point when data for April is released next week.