The Bank of England governor, Andrew Bailey, expects inflation to “fall quite markedly” this year, calling into question the need for a further interest rate rise when policymakers meet later this month.
Delivering a positive message to MPs that inflation was on a downward path, Bailey said falling energy prices and a weakening labour market meant the cycle of interest rates rises was nearing its end.
Currency traders reacted to the message by selling the pound, pushing sterling down below $1.25 for the first time in three months.
The governor said “I think we are much nearer now to the top of the cycle” as he described how wages rises were falling and the economy slowing in response to 14 consecutive increases in the cost of borrowing since December 2021.
Financial markets continue to expect the central bank’s monetary policy committee (MPC) to increase interest rates by 0.25 percentage points to 5.5% when it meets on 21 September.
Putting a 82.5% probability on a quarter point rise, down marginally from 85% earlier in the day, financial markets have effectively priced in a rise to the highest level since December 2007.
Speaking to MPs on the Treasury committee, Bailey said many economic indicators were signalling that the fall in inflation will continue this year. The consumer prices index (CPI) dropped to 6.8% in July, down from 7.9% in June.
He said: “As I’ve said a number of times, I think [the fall in inflation] will be quite marked by the end of this year.
“The question now is, as headline inflation comes down and people become more confident, that we will we see inflation expectations continue to come down too, and be reflected in wage bargaining?”
He said inflation expectations among consumers and businesses had moderated in recent months and firms had reported offering lower wage rises, with salary increases falling to 5% on average from above 6% only a few months ago.
The Bank of England deputy governor, Sir Jon Cunliffe, cautioned MPs that there were “mixed signals” about the path of inflation.
He said pay growth was strong, despite the drop in inflation and the service sector was pushing up prices at an unexpectedly high rate month on month.
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The nine-strong MPC was split when it voted to increase interest rates in August.
Swati Dhingra, an MPC member, said she was less concerned about the likelihood that services prices would moderate, arguing that the nature of services industries meant there was a long time lag before interest rate rises took effect.
Dhingra voted at the last meeting to keep rates on hold, arguing that the cumulative effect of increases the cost of borrowing had yet to have their full effect on economic growth.
Bailey said a rise in oil prices last month was likely to push up inflation in August when it is reported later this month, but said the increases will prove to be a blip – something echoed by the chancellor Jeremy Hunt in response to a recent rise in prices at the fuel pumps. The central bank expects the CPI to return to its 2% target by the end of next year.
“I should say possibly that we will get a tick up in the next release because fuel prices went down in August last year and went up a bit in August this year,” Bailey said.
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