The UK government has left management of inflation almost entirely to the Bank of England, which has a remit to keep inflation to around 2% per annum. And the Bank of England has only one policy lever at its disposal to deliver on this remit: interest rates.

As we wrote over a year ago, there is a serious risk of mis-handling inflation in the UK. We said that if you wanted to mishandle inflation, you would:

“treat it as a single, simple issue; mistake inflation for a measure of ability to buy; assume that low inflation is a sign of a strong economy; panic about it; and, most importantly, use the wrong tools to contain it.

In the UK we are set to make all five of these mistakes.”

Specifically, we warned that unless the type of inflation we face is domestically-driven, demand-pull inflation, interest rates are not the solution to the problem. And we said that the Governor of the Bank of England should explicitly tell the Chancellor that fact.

The Governor’s letter to the Chancellor on 22 June 2023 showed that Andrew Bailey is fully aware that this is not domestically-driven, demand-pull inflation – but gave no hint that the Bank is recommending any solution other than high interest rates.

We then expanded on the problem and showed that pursuing an interest-rate ‘solution’ risked crippling the UK economy, and again suggested that the Governor write accordingly to the Chancellor. He has not yet done so.

The Bank of England has itself now recognised that the proportion of UK companies facing debt stress – ie being at real risk of bankruptcy – will rise to 50% by the year-end. Its analysis also shows that for smaller businesses, the proportion is likely to be even higher: up to 70%.

Bankruptcies are already running at well above normal rates, and if they rise much further will return to the territory they reached during the Global Financial Crisis.

To help the Governor, we have drafted the letter he should now send to the Chancellor.

Conclusion

The Bank of England is not incompetent: as the letters to the Chancellor and analyses referred to above indicate, the Governor fully understands both the causes of our inflation and the damage high interest rates will do to the UK economy.

He must now have the courage to do what is right for the country rather than meekly following an inappropriate remit.

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