A senior Bank of England policymaker warned that the central bank could have to raise interest rates to prevent inflation from becoming established in the economy.
Catherine Mann, an independent economist on the Bank's rate-setting monetary policy committee MPC said that there were material upside risks to inflation sticking at higher levels than expected as the impact of the Covid epidemic, Russia's war in Ukraine and Brexit on the economy.
In a speech in Budapest on Monday, she said that the UK suffers not only from the Covid and energy shocks but also from the negative supply shock the worst of all worlds. She was outvoted by her colleagues last week as she pushed for a bigger rate increase than the 0.5 percentage point rise announced by the central bank.
She said that further increases would be required, with the Bank's base rate now at 4%, the highest level since 2008. In my view, the next step in the Bank rate is more likely to be another hike than a cut or hold, and that is why we need to stay the course.
Her speech came amid City speculation that Threadneedle Street is nearing the peak of its most aggressive tightening cycle in decades, after a modest fall in the headline inflation rate and the economy teeters on the brink of recession. Financial markets expect a more than a 0.25 percentage point increase this year before Britain's worsening economic slowdown forces the Bank to cut rates.
Inflation has fallen from more than 11% in October to 10.5% in December, with most economists expecting a decline this year as the initial surge in energy prices after the Russian invasion diminishes in significance for the annual inflation rate.
There are risks that inflation has so far stabilised at high levels, but it is not yet the harbinger of a turning point towards a return to the 2% target set by the government for the Bank to achieve.
She said that the British economy was also affected by the Covid epidemic and the energy shock. She said that the UK has been affected by a third type of shock, which makes it unique: no other country has unilaterally imposed trade barriers on its closest trading partners.
Mann said that the Bank should be cautious by responding to further rate increases because of the risk of inflation remaining higher for longer.
She said that the costs of making a mistake are larger if the true inflation process is more persistent than if the true inflation process is less persistent.
A tighten-stop tighten-loosen policy boogie looks like fine-tuning to be good monetary policy. It is hard to communicate and to transmit through markets to the real economy.