The Bank of England came out swinging at inflation — and, implicitly, at its own critics — when it raised interest rates on Thursday by twice what investors had expected. That markets took the move largely in their stride is a sign of how serious they believe Britain’s persistent inflation problem has become. The 50 basis point increase — taking the base rate to 5 per cent, its highest since 2008 — and the hawkish tone in its accompanying statement were welcome signs of intent to get a grip on soaring prices. But the BoE needs to do much more to regain the confidence of investors, and households, that it is up to the task.

There is no longer much doubt that Britain is an outlier on inflation. While price growth has fallen recently in the US and eurozone, it stayed stuck at 8.7 per cent in the UK last month. One or two upside wage and inflation surprises earlier this year were easier to look beyond, but these have now become a trend. Core price inflation, which excludes energy and food, rose in May to its highest in more than three decades, but is on its way down in America and Europe. The BoE can no longer hide behind global price pressures. Britain has its own inflation problem, and misjudgments by the bank’s Monetary Policy Committee have contributed to it.

A priority for central bankers over this rate-raising cycle was to prevent a dreaded “wage price spiral”; when high inflation becomes entrenched as rising prices drive up wage demands in a self-reinforcing process. The chance of this occurring in the UK has greatly increased — annual wage growth recently hit 7.2 per cent — as the BoE has consistently underestimated the risk of price growth becoming persistent. Indeed, in early March, its governor Andrew Bailey signalled that interest rates, then at 4 per cent, were close to their peak. Central bank governors embody their institution, and Bailey has too often appeared to be behind the curve rather than ahead of it.

Britain’s extra-tight job market has not helped. High levels of inactivity and changes to immigration rules post-Brexit have exacerbated staff shortages, which have added to wage pressures. This is out of the MPC’s control, but its failure to accurately assess the lack of spare capacity in the labour market has only made things worse. The BoE’s recently announced plan to review its forecasting processes will be important to avoid similar errors in the future.

Faith in the bank’s understanding of the economy is crucial to manage the rate and inflation expectations of investors, businesses and households. With each missed forecast, that has started to evaporate. A BoE survey showed public satisfaction in the institution had fallen to an all-time low last month. Financial markets have also nudged their end-of-year rate expectations up to 6 per cent — from about 4.5 per cent at the start of the year. Some analysts do not think they will need to go that high. Either way, markets are likely to price higher for now — representing a premium for the BoE’s past errors — and this influences how commercial banks price mortgages.

The BoE’s bold rate rise, coupled with Bailey’s pledge on Thursday to do “whatever is necessary”, was a step towards getting inflation under control. But it unfortunately means inflicting more pain on households and businesses and potentially even pushing the economy into a recession — Britain’s cost of living crisis is broadening out into a cost of borrowing crisis.

In coming weeks the MPC, and particularly the governor, will need to convince markets that the bank is resolute. Further rate rises will need to remain on the table. Its next meeting and quarterly monetary policy report in August will have to show it understands its errors, and has a handle on Britain’s inflation problem. The credibility of the institution is at stake.

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