Bailey draws a line in the sand
Andrew Bailey faced parliament. He sat before the Treasury Committee on 8 September not to offer comfort, but to deliver a specific and uncomfortable warning about the prices still rising too fast across the British economy. His message was stark. The fight is not over. The Governor used the formal setting, a session with elected MPs, to signal the Bank of England’s absolute resolve. Inflation, he indicated, remains the primary threat. It requires a forceful response. There will be no change of course. For anyone hoping for a signal that the worst of the mortgage pain was ending, there was none. Bailey drew a line.
Investors listened. They sold. The FTSE 100, the main index of Britain’s largest listed companies, slipped on the news, shedding value as traders calculated the real world cost of the Governor’s resolve. The logic is simple. Higher interest rates make it more expensive for companies to borrow and invest, while also squeezing household budgets and reducing consumer spending. A stock market fall is the City’s way of saying it expects leaner times ahead. Bailey’s words were not a surprise, but their confirmation in such a direct forum was enough to chill the mood on trading floors across London. The market now fully expects more rate rises.
This sets up a brutal question. Why is the Bank so determined to pursue a policy that will knowingly inflict financial pain on millions of households and businesses already struggling with the cost of living? The Bank’s own officials understand that higher rates make people poorer in the short term. They increase mortgage repayments, put some firms out of business and can trigger job losses. The pain is the point. The Bank believes that this short, sharp shock is the only reliable medicine to cure the deeper disease of persistent inflation, an economic sickness it fears could become embedded for a generation if left untreated.
The inflation we can feel
To understand the Bank’s actions, you have to look past the headline inflation figure. That number is the Consumer Prices Index, or CPI. The latest data from the Office for National Statistics shows it at 6.8 per cent. This is a fall from the painful double digit peaks of last year, a decline driven almost entirely by lower global energy prices. It looks like progress. It is not. Andrew Bailey and his colleagues on the Monetary Policy Committee are not looking at the headline number. They are looking underneath it.
The Bank’s real focus is on something called ‘core inflation’. It is a simple idea. It takes the main CPI figure and strips out the volatile prices of energy, food, alcohol and tobacco. What is left gives a much clearer signal about domestically generated price pressures, the inflation that is being baked into the British economy by ourselves. That number is dangerously high. It is stuck. While the headline figure has fallen, core inflation has barely budged for months, holding firm at 6.9 per cent. This is the figure that keeps central bankers awake at night.
The details are grim. The official data reveals exactly where the persistent price rises are coming from. Food inflation remains extraordinarily high at 14.9 per cent, meaning a shopping basket that cost £100 a year ago now costs almost £115. But the most stubborn problem is in the services sector. Think of mechanics, hairdressers or accountants. The price of these services is rising at an annual rate of 7.4 per cent, the highest in over thirty years. This is the inflation that is not imported in a shipping container. It is created here. It reflects the cost of labour in Britain. Your car insurance premium, the price of a restaurant meal, the fee for getting your boiler fixed. All are climbing.
This is the Bank’s justification. Officials see rising wages, a necessary response to last year’s price shocks, feeding directly into higher prices for services. This risks creating a feedback loop. It is a wage price spiral. Higher wages push up business costs, businesses then raise their prices to protect profits, and workers then demand even higher wages to keep up with the new cost of living. The Bank of England’s one big job is to prevent this cycle from becoming embedded. That is why it is using the only tool it has, higher interest rates, to cool demand across the entire economy. It is aiming to break the spiral. The target is not last year’s gas bill. It is this year’s pay rise.
How raising rates actually works
The process is brutally simple. It starts with one number. The Bank Rate. This is the interest rate the Bank of England charges to commercial banks like Barclays or NatWest when they borrow from it, the ultimate lender of last resort. When the Monetary Policy Committee votes to raise this rate, it is deliberately increasing the base cost of money for the entire United Kingdom financial system. The decision is announced at midday. The effect is almost instant. The cost for high street banks to borrow money goes up, a cost they have absolutely no intention of absorbing themselves. They pass it on. They pass it on to you.
For millions of households, the impact is direct. It is painful. Anyone with a tracker mortgage sees their monthly payment rise automatically, often within a month of the Bank’s decision. The same is true for those on a standard variable rate. A homeowner with a typical £200,000 tracker mortgage would see their annual payments increase by £500 for every 0.25 percentage point rise in the Bank Rate. The pain is not limited to existing variable loans. The price of new fixed rate mortgages also climbs, because the market rates that banks use to price these long term deals are heavily influenced by expectations of where the Bank Rate will be in the future. Business borrowing becomes more expensive. The loan for a new delivery van, the overdraft to manage cash flow, the finance for factory equipment, all of it costs more. Investment stalls.
There is another side to this calculation. Higher rates are not bad news for everyone. They are good for savers. The interest paid on savings accounts, after years of being pitifully low, begins to rise, rewarding people for putting money aside rather than spending it. The incentive structure of the economy shifts. Spending becomes less attractive. Saving becomes more attractive. This is not an accident. It is the entire point of the policy.
The Bank is pulling a very large, very blunt lever. By making borrowing more expensive and saving more rewarding, it seeks to drain demand from the economy. The goal is to get people and companies to spend less money. Less spending means less competition for a limited supply of goods and services, which should, in theory, cause prices to stabilise or fall. It is a slow, powerful and often clumsy mechanism. It does not target specific price rises. It cannot distinguish between a family struggling with food bills and a company making record profits. It just squeezes. The Bank is squeezing the whole economy to bring inflation back to its two per cent target.
The cure could be worse than the disease
Squeezing the economy is a dangerous game. There is a fine line between a controlled slowdown and a full blown recession, and the Bank of England is now walking it. The policy of high interest rates might bring down inflation. It might also bring down the entire economy. This is the gamble. The latest data on gross domestic product from the Office for National Statistics already shows an economy that has stopped growing, teetering on the edge of contraction before the full impact of recent rate rises has even been felt.
For now, unemployment is low. That has been the one bright spot. But the Bank’s own forecasts accept that its policy will likely push more people out of work as companies stop hiring and start shedding staff to cope with higher borrowing costs. The ideal outcome is what economists call a 'soft landing'. A soft landing is the central banker’s dream, a perfectly executed manoeuvre where inflation is gently guided back to the two per cent target without causing a major recession, without triggering mass unemployment and without crashing the housing market. It is a delicate, almost impossible, feat of economic engineering.
The alternative is a hard landing. The economy shrinks. Businesses fail. People lose their jobs. This is not just a statistical event recorded in ONS quarterly reports, it is a period of real hardship where a deliberate policy choice made on Threadneedle Street leads to rising bankruptcies and longer dole queues across the country. Some at the Bank may see a shallow recession as a price worth paying to defeat an inflation problem they allowed to get out of control. Many households facing job losses or business owners staring at insolvency will not agree. The cure could be worse than the disease.
The view from number eleven
The Bank of England is independent. Its decisions on interest rates are made on Threadneedle Street, not in Downing Street, a principle established in 1997 to keep short term politics out of monetary policy. The politics are brutal. The theory is that this separation allows the Bank to take tough, unpopular measures for the long term good of the economy without worrying about the next election cycle. The reality is that the Bank’s decisions create immense political problems for the person who lives next door to the Prime Minister. The Chancellor of the Exchequer must answer for the consequences.
Every mortgage holder whose monthly payment has jumped is a voter. So is every business owner who can no longer afford a loan to expand. Nobody likes higher rates. While Andrew Bailey can talk clinically about the necessity of cooling demand, the Chancellor has to face a party and a country feeling the acute pain of that cooling. An election is on the horizon. The government would much rather be heading into it with a growing economy and falling borrowing costs, not with a self induced slowdown designed to tame an inflation problem that began on its watch. This creates a fundamental, structural conflict between the aims of the government and the legal mandate of the Bank.
This tension is not new. It is baked into the system. Friction between chancellors and governors is a recurring feature of British economic life, but it becomes particularly sharp when the Bank’s medicine tastes as foul as it does today. The Chancellor has few good options. The government is ultimately held responsible by the public for the state of the economy, yet the most powerful tool for managing it is controlled by an unelected committee. All the Treasury can do is offer fiscal support, like cost of living payments or tweaks to taxes, which can sometimes work against the Bank’s aims by putting more money into the economy. The government cannot instruct the Bank to change course. It cannot fire the governor. It can only sit and watch as interest rates rise, hoping the economic landing is soft, knowing it will get the blame for a hard one.
What to watch in the months ahead
All eyes are on Threadneedle Street. The next critical date is the upcoming meeting of the Monetary Policy Committee, the nine member group responsible for setting the Bank Rate. That decision will be almost entirely shaped by a single number. This is the headline inflation figure, which the Office for National Statistics will publish a week or so before the committee convenes to cast its votes. If that ONS data shows that price rises, particularly for services and food, are still stubbornly high, another interest rate rise becomes a near certainty. The Bank’s mandate is to return inflation to its 2 per cent target. Andrew Bailey has made his position clear. He will use the tools he has to achieve it.
This policy has clear losers. Millions of them. The pain is most acute for anyone with debt. Homeowners on tracker or variable rate mortgages see their monthly payments rise almost immediately after the Bank acts, directly hitting their disposable income. A far larger group, the roughly two million households whose cheap fixed rate deals are due to expire in the coming year, faces a far more severe financial cliff edge. Their new reality will be borrowing costs double or even triple what they have been used to. Businesses also suffer. The cost of borrowing to invest in new machinery, expand a factory or hire more staff becomes prohibitive, leading many firms to shelve plans for growth. This is the mechanism for slowing the economy. It is a painful one.
There are, however, winners. Savers are the main beneficiaries. For more than a decade after the 2008 financial crisis, holding cash in a bank account meant watching its real terms value be steadily eroded by inflation, however low. Now, the reverse is true. Higher interest rates from the Bank of England create competition among high street banks, forcing them to offer much more attractive returns to people willing to put money aside. Another group also stands to gain from a higher Bank Rate. This group is anyone holding pounds. A tighter monetary policy tends to strengthen sterling against other major currencies like the US dollar and the euro, because international investors are attracted by the higher returns on offer. A strong pound also lowers the cost of all the goods the UK buys from overseas.
This is the balance the Bank must strike. It is a terrible calculation. The destination is clear. The gains for savers, while welcome, are spread thinly and are unlikely to generate a powerful economic boost on their own. The benefit of a stronger pound can also feel remote. By contrast, the pain for borrowers is sharp, concentrated and has a direct, chilling effect on consumer spending and business investment, which are the main engines of the entire economy. The coming months will be defined by these competing forces. The Bank of England will watch the data, from inflation to jobs figures, and make its choice. The question is how much economic damage the country will sustain on the way to 2 per cent inflation.
Sources. Independent Business: FTSE 100 slips as Bank of England chief flags inflation risks. Evening Standard: FTSE 100 slips as Bank of England chief flags inflation risks.
Analysis. Drafted with AI assistance from the sources listed above and reviewed by an editor before publication. Jnews links to the organisations it writes about.
