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The writer is vice-chair of Evercore ISI and a former member of the management committee of the New York Fed

The UK inflation report for May is a hammer blow for the Bank of England ahead of its June decision on interest rates on Thursday. It shows inflation unchanged at 8.7 per cent with core inflation (excluding food and energy) and services inflation rebounding higher.

This demands a clear response from the BoE. It must show that it will do whatever is required to bring inflation back under control and that it has a credible strategy for doing so.

As private sector wages also rise, there is evidence of “second round” effects that threaten to entrench high inflation in the UK, with workers seeking to claw back income after years of miserable real wage growth, companies passing on cost increases to customers, and a slippage in the inflation expectations that form the basis for negotiating wages and prices.

The bank has been dealt a uniquely terrible hand. Brexit reduced the potential output of the UK economy and reduced competition, making UK inflation dynamics vulnerable to the shocks caused by the pandemic and then the war in Ukraine.

The problem has been amplified by an insufficient response from the BoE, which has consistently lowballed the extent of the tightening that might be required to tame inflation.

What, then, should the bank do? It could try to shock inflation expectations by delivering a surprise 50 basis point rise, rather than the expected 25bp increase. But doing that in isolation would not have a lasting effect and would leave it with the following problem: would the default then be 50bp until the data turns decisively?

What is needed is a decisive shift in strategy to strengthen inflation credibility, with decisions on rate rises following from the strategy not substituting for it. This would start with a simple unambiguous message that the BoE will do whatever is required to bring inflation back to target.

It is not the central bank’s job to ask people to accept lower wages and companies to accept lower profits. Its job is to ensure that conditions are such that they cannot demand more than is consistent with the 2 per cent inflation target.

To implement this, the bank needs to signal that it will conduct policy with a laser-like focus on bending the trajectory of inflation in the next 12-18 months decisively back towards its 2 per cent target. It would say it would be prepared to cause a recession if that is what it takes, given that there is no long-run trade-off between inflation and employment.

The BoE could start with a single rise of 50bp and then step down to 25bp; alternatively, it could signal a series of 25bp rises, with an option to step up to 50bp if inflation dynamics worsen further — or else slow to one increase every other meeting if the data improves.

The risk, though, is that the bank instead tries to muddle through or talk down market rate expectations that have pushed mortgage rates sharply higher. This would be a mistake. While the recent surge in rates has superficial similarities with last September’s “mini” Budget fiasco, this time it is monetary, not fiscal, credibility that is at stake.

With investors concerned about “mortgage dominance” — the idea that the bank may be constrained by concerns about mortgage resets and house prices — an excessively dovish approach would backfire. The only durable way to lower mortgage rates is to bring inflation back under control.

This will be a test of the BoE’s governance model in which every rate-setter is charged with making an independent decision on the best rate outlook. This may make executive leadership harder than at the US Federal Reserve or the European Central bank, but the onus is on the Monetary Policy Committee to show it does not prevent a decisive response to this clear and present danger.

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