Unemployment must be higher to keep a lid on inflation, Bank of England’s Huw Pill claims

Unemployment must be higher to keep a lid on inflation, Bank of England’s Huw Pill claims

14 Apr    Finance News, News

A greater proportion of the UK population than before the recent series of economic shocks may need to be unemployed in order to keep a lid on inflation, the Bank of England’s chief economist has claimed today.

Huw Pill, who succeeded Andy Haldane as the Bank’s top wonk, was speaking at an event hosted by Market New. Pill said the natural rate of unemployment has risen as a result of the Covid-19 crisis and Russia’s invasion of Ukraine choking the economy.

Pill, a former Goldman Sachs banker, said the Monetary Policy Committee (MPC), the group of experts who set interest rates in the UK, need to see an increase in joblessness to “reassure” them that inflation is headed back towards their two per cent target.

He agreed that the so-called “natural rate of unemployment”, a phenomenon in economics that tries to pinpoint the level of joblessness needed to ensure inflation doesn’t spiral out of control, has climbed due to a reduction in the UK’s economic potential since the pandemic.

Central banks tend to try to lift unemployment when prices are rising rapidly to reduce demand – which should, in theory, put downward pressure on inflation.

Banks do this by raising interest rates, which raises businesses’ costs and narrows their capacity to take on additional workers. The UK’s unemployment rate has been hovering around multi-decade lows for over a year.

Britain has suffered a severe terms-of-trade shock, meaning it has seen the amount of money it pays for its imports soar far above the income it receives from selling goods and services around the world.

That jump has been primarily been caused by Russia’s invasion of Ukraine which jolted international energy prices up sharply.

Higher import prices have also played their part in pushing UK inflation to its highest level in 40 years and far above the Bank’s target, rapidly eroding household and business finances.

While projected to fall quickly this year, inflation has been in the double digits since September and is currently running at 10.4 per cent.

Pill said the Bank has hiked interest rates 11 times in a row – at the fastest pace since the 1980s – up to a post-financial crisis high of 4.25 per cent to prevent high inflation embedding in the UK for the long term.

At current rate levels, “we do think we are weighing against inflation,” Pill said.

He explained that firms and families are trying to “resist inflation” by bidding up wages and margins which, if successful, would protect their balance sheets.

Albeit a rational response to soaring living costs, this dynamic risks creating an inflationary cycle in which policymakers would end up having to impose a tough recession to hose down prices.

Markets reckon the Bank will nudge borrowing 25 basis points higher at its next meeting on 11 May. New numbers out next Wednesday are expected to show inflation dropped below 10 per cent in March.

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