As the Bank of England scrambles to try and tame inflation with aggressive rate hikes, Bank of England Gov. Andrew Bailey warned during a speech this week that the British economy is sliding into stagflationary hell as the energy price crunch spurs inflation that's hotter than at any point during the 1970s.
While HMG has sought to alleviate the impact of higher energy prices with direct fiscal transfers to millions of British families (perhaps they should ask the San Francisco Fed how that might turn out), Bailey warned that the British economy is already on the cusp of slipping into stagflation.
According to Bailey, surging energy costs have forced the BoE's Monetary Policy Committee to confront the biggest challenge in its short history (it was former in 1997): how can a central bank tackle inflation without driving the economy into recession?
Assuming the war in Ukraine drags on (the latest headlines point to a breakthrough in peace talks, but whether progress actually materializes remains to be seen), Bailey expects the UK's consumer-price inflation to top 8% during the second quarter (it's already higher than 6%, more than 3x the central bank's inflationary target).
These inflationary pressure represent a "historic shock" to incomes.
Bailey said Britons were facing a "very large shock to aggregate real income and spending" from rising prices of energy and imported goods. He told an event organised by Bruegel, the think-tank, in Brussels: "This is really an historic shock to real incomes."
One of the main differences between today and the 1970s is that the oil shock back then lingered for years, while Bailey said he and his fellow policymakers hope that this latest bout of inflation will start to ease before the end of the year.
"The shock from energy prices this year will be larger than any single year in the 1970s. The caveat is that the 1970s had a succession of years and we very much hope that would not be the case now. But as a single year, this is a very, very big shock."
To further underscore the difficulty of the situation, the British Office for Budget Responsibility predicted that UK household real income this year would contract at the sharpest rate since records began in the 1950s. Meanwhile, the OBR cut its UK growth forecast for 2022 from 6% to 3.8%.
Bailey said: "We expect it to cause growth and demand to slow. We’re beginning to see the evidence of that in both consumer and business surveys."
With its inflation and growth forecasts pulling the central bank in different directions, Bailey suggested that the BoE is now caught between a rock and a hard place.
"This is a big trade-off," he added. "I think it’s the biggest trade-off the Monetary Policy Committee has faced in its now approaching 25 years life."
The prescription, of course, is QT and rate hikes. And with the conservative government reluctant to embrace the level of fiscal expansion seen abroad (most notably in the US), Britons should probably brace for hard times ahead, as the only cure for runaway inflation is demand destruction.