Andrew Bailey has blamed a wave of early retirement for forcing up interest rates and inflation as Britain battles the steepest price rises of any large rich country.
The Governor of the Bank of England said that a sharp decline in the number of people in the workforce was “part of the reason why we have had to raise Bank Rate by as much as we have”.
Mr Bailey’s comments are the clearest sign yet that the Bank is concerned about the number of people retiring early amid a race by the Chancellor Jeremy Hunt to get more people back into work.
He said: “We should expect this to put upward pressure on inflation in a way that would call for a higher level of interest rates to dampen demand.”
Mr Bailey said the rise in inactivity of people aged 50 to 64 was “particularly striking”.
The workforce has shrunk by 0.4pc compared with before the pandemic, the Governor pointed out, equal to a decline of 132,000 people. Before Covid it had been steadily growing over past decades.
The Treasury has long been worried that higher economic inactivity – driven in part by people retiring earlier – was holding back the economy.
Mr Hunt used his Budget earlier this month to encourage over-50s to stay in work longer with a raft of measures such as scrapping a cap on the amount that can be saved in a pension pot without paying tax.
Mr Bailey said the measures announced in Mr Hunt’s maiden Budget to address the shrinking workforce were “very welcome and important”.
He added: “I welcome them, I think they’re really addressing the right things.
“I’m pleased we’re having more of a national debate on the labour supply because it’s very important.”
The Bank of England has been forced to increase interest rates at 11 consecutive meetings of its Monetary Policy Committee (MPC) in an attempt to get inflation under control, bringing them to 4.25pc – the highest level since the dawn of the financial crisis in 2008.
Its actions have increased the average two-year fixed rate mortgage from 1.99pc in the summer of 2020 to 5.32pc, according to financial data website Moneyfacts, adding £360 a month to the cost of a typical £200,000 loan.
Interest on savings – which is likely to benefit people with assets, such as those retiring early – has also risen, with the average easy access rate climbing from 0.24pc to 1.74pc last month.
Despite the Bank’s actions, inflation still stands at 10.4pc, more than five times its target and the highest rate in the G7 group of major economies.
In his speech at the London School of Economics, Mr Bailey said that this had been triggered by a combination of crises such as Covid and the Russian invasion of Ukraine, as well as post-Brexit changes to the country's trading relationship with the European Union.
He said: “These shocks have affected the UK economy in different ways. But they have all eroded the terms on which we trade with the outside world.
“This has made us poorer as a country, manifesting itself in a rise in the prices we have to pay for the things we buy as consumers.”
He added that the sharp and unexpected fall in the number of people in the workforce since lockdown was partly responsible.
Mr Bailey said that people taking early retirement are spending savings to maintain their lifestyle, maintaining demand in the economy, at the same time as dropping out of the workforce and reducing the supply of labour.
He said: “The rise in economic inactivity is a change to the supply of labour, independent of demand, in particular by older workers.
“If those workers have accumulated enough savings to sustain a desired level of consumption much like the one they had before their early retirement, at least for a while, aggregate demand will not have fallen by as much as aggregate supply.
“We should expect this to put upward pressure on inflation in a way that would call for a higher level of interest rates to dampen demand.”
The UK is near unique among rich countries in having a workforce that remains smaller than before the pandemic.
Economists believe it has been driven by a surge in people taking early retirement after spending less time working during the pandemic and a rise in people suffering from long-term illnesses.
Some experts believe record NHS backlogs are to blame too. However, there is still much uncertainty about why Britain’s workforce has shrunk so much and whether it will ever fully recover.
The latest figures from the Office for National Statistics show that the employment rate is now at 75.7pc, down from 76.6pc before Covid struck.
In a wide-ranging speech, Mr Bailey also said that he expects inflation and interest rates to fall over the longer term because of a savings glut built up by the country's ageing population.
Although this month's inflation reading surprised economists, who had expected it to drop to 9.9pc, Mr Bailey said that he nonetheless expects price rises to slow in coming months as falling energy costs take effect.
Mr Bailey said he expected inflation to fall back sharply in a couple of months amid rapidly falling gas prices.
The Governor also said innovations in technology, such as artificial intelligence programmes like ChatGPT, could lead to a rise in productivity and have an impact on future interest rates “which would have to move with it”.
Mr Bailey added that British banks are safe despite the recent turmoil in financial markets after Silicon Valley Bank’s collapse in the US and Credit Suisse’s rescue in Europe.
He said: “We believe the UK banking system is resilient... and well placed to support the economy.”
Mr Hunt announced in his Budget earlier this month that he would scrap a cap on the amount people can save over their lifetime in their pension pot before they are taxed.
Many professionals, such as NHS consultants, complained it was not worth their while to continue working after they had reached their lifetime pension allowance, which stood at £1.07million.
Mr Hunt also increased the annual tax-free pension allowance from £40,000 to £60,000.
The Chancellor also pledged to expand mid-life MOTs, under which the over-50s can receive financial advice to check whether they can actually afford to retire.
And he announced a new type of apprenticeship, called a “returnership”, for the over-50s wanting to return to work in a new sector.
The Office for Budget Responsibility estimates that all of Mr Hunt's measures will add another 110,000 workers to the workforce over the next six years, while higher than expected immigration is predicted to provide a boost of 160,000 compared with forecasts from November.
Mr Bailey said that it would take time to judge whether the policies are effective.