Bank of England governor Andrew Bailey has called on governments to pursue credible, disinflationary tax and spending policies, with his Bailey fiscal restraint warning arriving at an awkward moment for Chancellor John Healey as he prepares to deliver the Budget later this month.
Speaking at the Istanbul Economic Forum, Bailey urged governments to weigh the inflationary consequences of their spending and borrowing decisions. He is also chair of the global Financial Stability Board.
‘Whatever the stance of fiscal policy is, it must be credible and direct to that stability, and seen to be as such by markets,’ Bailey said. He added that fiscal rules could play an important role in securing price and financial stability, ‘just like inflation targets.’
Bailey fiscal restraint warning lands as gilt yields climb
The timing of his remarks is uncomfortable for Healey. The 10-year gilt yield, the benchmark for UK government borrowing costs, has climbed from around 4.2 per cent in March to nearly 5.5 per cent, piling billions onto the Chancellor’s debt interest bill. Healey must reconcile higher debt payments with pledges to support households on the cost of living and businesses on their own cost pressures.
Bailey was careful to mark the boundaries of his role. It was not for him, he said, to ‘comment on fiscal policy and thereby cross the line beyond central banking.’ But the thrust of his argument was plain: fiscal credibility and monetary stability are intertwined, and governments that fail to demonstrate one make the other harder to achieve.
‘A continued commitment to the policy stance can then help to control the emergence of risk premia, something that is likely to happen otherwise when a major conflict in the Middle East breaks out,’ he said. ‘Such commitments are needed more than ever when these negative shocks occur.’
Energy prices and the limits of a look-through approach
At the centre of Bailey’s concern is the trajectory of energy costs. The Bank of England expects inflation to rise above four per cent in the coming months as the UK is exposed to elevated global energy prices. Brent crude, used as a marker for energy costs, jumped from $90 to over $100 a barrel in the past month.
UK inflation in the 12 months to August stood at 3.1 per cent, already above the Bank’s two per cent target. Under its mandate, Bailey must write to the Chancellor to explain any overshoot beyond three per cent.
Bailey warned that the longer energy prices remained high, the more ‘difficult’ it would become for the Bank to treat the situation as temporary. The so-called look-through approach, under which the Bank tolerates short-term price spikes without tightening policy, depends on inflation expectations staying anchored. ‘If households and firms start building this shock into their wage and price setting behaviour, this temporary effect quickly turns into a persistent effect,’ he said.
On the UK specifically, Bailey acknowledged that recent history had elevated the risk. ‘We are conscious that the history of recent years pointed to a risk of elevated inflation expectations,’ he said.
The Bank is widely expected to raise interest rates to four per cent at its next meeting, scheduled a week after the Budget.
Bailey was not alone on the podium in Istanbul. According to the Central Bank of the Republic of Turkey (TCMB), U.S. Federal Reserve Governor Christopher J. Waller also delivered a keynote address at the forum. The presence of two major central bank figures on the same platform underlines the weight that monetary policymakers are placing on the interplay between government spending decisions and price stability.
Concerns about government borrowing are not confined to Bailey. International Monetary Fund managing director Kristalina Georgieva warned earlier this year that higher government debt levels are leaving countries vulnerable in an economic downturn.
Bailey also touched on financial markets more broadly, saying that high levels of leverage used for artificial intelligence investments had increased risks, though markets had not become ‘disorderly.’ ‘We can’t in any way be relaxed about the current state of financial markets,’ he said. The remark serves as a further reminder that, whatever Healey decides later this month, the Chancellor will be doing so under close scrutiny from Threadneedle Street.
