(Bloomberg) -- The UK Labour government’s tax rises reinforce the Bank of England’s gradual approach to easing interest rates, BOE Governor Andrew Bailey said.
Employers could choose to react to the hike in their National Insurance contributions — which lifts the cost of employment — by raising prices charged to consumers, absorbing the costs themselves, reducing the pace of wage rises or by cutting hiring, Bailey said on Tuesday in his annual report to Parliament’s Treasury Select Committee.
“There are different ways in which the increase in employer National Insurance Contributions announced in the Autumn Budget could play out in the economy,” Bailey said. “A gradual approach to removing monetary policy restraint will help us to observe how this plays out, along with other risks to the inflation outlook.”
Bailey’s latest remarks paint a more nuanced picture of the way in which Chancellor of the Exchequer Rachel Reeves’s budget is impacting the UK economy. The budget complicates an already uncertain economic picture for the UK, where inflation is expected to climb back above the bank’s 2% target when new figures are published on Wednesday. A potential revival of trade protectionism after Donald Trump’s return to the White House, geopolitical risks and sticky services inflation are other factors feeding into the BOE’s course of action.
Bailey was among four members of the Monetary Policy Committee testifying before the Commons panel on Tuesday. Speaking to the committee, Bailey warned against greater fragmentation in the world economy, even as he declined to comment on the potential effects from US tariffs.
A self-described “dyed in the wool free trader,” he urged the UK to maintain an “active dialogue” on trade policies with both the future Trump administration — which has threatened to slap 10-20% tariffs on goods imports, and the European Union — the largest market for UK exports.
“I find it hard to understand people who seem to say that we should implement Brexit in the most hostile fashion possible,” Bailey said. “Having a relationship with the European Union is the better way to do it.”
Speaking alongside Bailey were colleagues including Alan Taylor, making his first public remarks since joining the policy committee in September, together with Deputy Governor Clare Lombardelli and external member Catherine Mann, the sole voter who wanted no change in borrowing costs this month.
Gradualism
While Bailey and Lombardelli strengthened the case for gradualism, Taylor suggested the possibility of a more aggressive approach which would entail easing at consecutive meetings. At the other end of the spectrum was the “activism” espoused by Mann, who pledged to hold out until there was clear evidence that price pressures had been subdued and then cut aggressively.
“If conditions are weaker, and my own views skew to the downside risk now versus the upside risk of about a year ago, then we could go faster,” Taylor said. Taylor said he was focused on the labor market, which risk dislocation as a result of the national insurance rise.
The BOE eased interest rates by 25-basis points for a second time in November and made a case of gradual easing going forward. That’s taking a more cautious approach than euro zone peers, and aligns closer with the tone of US Federal Reserve chief Jerome Powell.
Bailey warned of “lingering persistence in wage pressures” beyond the BOE’s current projections. Firms surveyed by the Bank are forecasting 4% wage growth in the year ahead, while the labor market remains relatively tight, despite some signs of loosening.
The increase in employer payroll taxes to 15% from 13.8% comes on top of a hike in the minimum wage, the third large increase in three years, which could further weigh on companies. If Labour’s budget decisions ultimately feed into rising prices, that will likely mean the Bank has to keep interest rates higher for longer, which would weigh on the government’s defining goal of stimulating growth.
Unemployment Risk
Bailey suggested there is “a risk” that these changes could be mostly passed on through lower employment, referencing a letter to Reeves on Tuesday from the British Retail Consortium.
“The national living wage is a very prominent subject of discussion,” Bailey said testifying to the Treasury Select Committee. “I can tell you that it is clearly on the minds of the companies.”
In the letter to Reeves signed by 81 chief executive officers, the BRC estimated the combined costs to retailers of the rises to national insurance and the national living wage, as well as a new packaging levy, total some £7 billion ($8.8 billion) a year.
“For any retailer, large or small, it will not be possible to absorb such significant cost increases over such a short timescale,” the BRC said. “The effect will be to increase inflation, slow pay growth, cause shop closures, and reduce jobs, especially at the entry level.”
(Updates with comments on wage pressures, effects of government policy, starting in fifth paragraph.)
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