By Geoffrey Smith
Investing.com -- Bank of England Governor Andrew Bailey warned incoming Prime Minister Liz Truss against ending the central bank's independence on Wednesday, saying that the current high rate of inflation doesn't prove that the bank's operational framework is a failure.
Truss, who was confirmed as U.K. Prime Minister earlier this week after winning the Conservative Party's leadership contest, had suggested bringing the Bank under closer government control during her campaign, saying that its huge money creation over recent years had led to inflation getting out of control.
She intends to hold a review of the Bank's competencies in the near future, a prospect that economists have warned risks politicizing the setting of interest rates as it did in the 50 years after World War 2.
Bailey said he wouldn't stand in the way of a review of its mandate, noting that such reviews are standard events across the world. But he pushed back strongly against Truss's criticisms in testimony to the Treasury Select Committee, saying that external factors - especially the role of energy prices - were responsible.
"I don't think you can use the money supply as...a straightforward and direct indicator of inflation," Bailey said, noting that the relationship between the two had broken down too often in recent years for it to be seen as reliable.
"This is by far the biggest shock we are facing" in the 25 years since Tony Blair's government restored the Bank's traditional sovereignty over monetary policy, Bailey said. "But it does not suggest that the regime has failed. It suggests that the regime has to do its work to deal with this shock."
At 10.1%, the U.K.'s annual inflation is at its highest in over 40 years, more than five times the Bank's target of 2%. It has forecast inflation to peak at over 13% in the coming months as the lagged effects of energy market turmoil gradually feed through into the broader economy.
One of the factors contributing to that inflation has been the weakness of sterling, which is testing a five-decade low. It fell again on Wednesday to trade at $1.1480 by 06:00 ET (10:00 GMT)
Bailey argued that much of sterling's decline was "a dollar story", given that the Federal Reserve has been able to raise interest rates much more sharply, without the same constraint from energy prices that is hurting the U.K. and Eurozone.
"The U.S. isn't working with the same trade-offs on inflation and activity," Bailey said.
However, he also acknowledged that the U.K. is facing other, longer-term problems, singling out its low productivity growth over a period of "at least 15 years".