Ahead of the UK interest rate decision, the central bank governor downplays inflation threat: secondary effects remain "relatively moderate".

Bank of England (BOE) Governor Andrew Bailey insists that the UK has not yet seen a significant second-round inflation effect and remains cautious regarding forward guidance on monetary policy. However, both market pricing and internal disagreements indicate that policy uncertainty is rising ahead of the September 17 rate decision.

Bailey said on Friday in an interview at the Jackson Hole Economic Symposium in the US that the UK labour market has remained weak, second-round inflation effects are fairly mild, and "I think for now we can continue to observe this situation." This is his first public comment on monetary policy since the July 30 policy meeting.

Despite Bailey’s dovish stance, market bets on rate hikes have clearly escalated. Traders have fully priced in a 25 basis point rate hike this year, and are betting on another hike next spring; short-term UK bonds have also underperformed their US counterparts.

Meanwhile, Committee member Catherine Mann warned at the symposium of the potential impact on UK monetary policy transmission from spillover effects out of the US and the rising dominance of the dollar.

Bailey’s latest remarks continue his post-July rate decision commentary. At the time, he joined a six-to-three majority in voting to keep rates unchanged, and made it clear at the subsequent press conference that "please do not leave this room thinking the Bank of England is leaning towards a rate hike."

At Jackson Hole, Bailey reiterated this stance, stating that current second-round inflation effects are "fairly mild" and the labour market has continued to weaken. He also stressed that the BOE is assessing decisions on a meeting-by-meeting basis and is wary of offering strong forward guidance.

"The problem with forward guidance is that it tends to make unconditional policy statements, which is where the danger lies," Bailey said, noting agreement with comments made earlier at the same event by Federal Reserve Chair Walsh.

Currently, the main driver behind heightened market rate hike expectations is stronger inflation data. The latest UK CPI figures show inflation rising for the first time since March, mostly driven by energy price increases caused by tensions in Iran.

Consumer confidence surveys show that in August, households’ expectations for price increases over the next year rose to 3.9%, roughly double the BOE’s target.

Meanwhile, European Central Bank officials have already leaned towards a second rate hike since the outbreak of the conflict, with eurozone inflation holding around 3% on the back of stronger-than-expected economic growth. The protracted conflict between the US and Iran is exacerbating the risk of a global energy shock evolving into a more broad-based inflation crisis.

However, signals from the UK labour market are diverging sharply from inflation trends. Companies are laying off staff, job vacancies have fallen to a five-year low, and private sector wage growth continues to slow. Bailey pointed out that these factors support his cautious optimism regarding second-round effects, but also admitted: "I can’t promise this situation will persist."

The BOE’s internal views are not unanimous. Catherine Mann, one of the minority who voted for a rate hike in July, warned in an interview at Jackson Hole about US spillover effects, and later at the symposium highlighted the deeper risk posed by the increasing dominance of the dollar.

"The implication for monetary policy is that policy transmission could face potential weakening," Mann said. She pointed out that the pound’s geopolitical and institutional erosion relative to the dollar is creating greater resistance for the BOE in steering the UK economy.

Mann’s remarks contrast sharply with Bailey’s tone, revealing deep divisions within the BOE’s policy committee regarding the pace of rate hikes and the assessment of external risks. As the September 17 decision approaches, market bets on the BOE’s policy path are likely to remain divergent.