Bailey warns lower growth and repeated supply shocks strain public finances

Centre · 1Bank of England Governor Andrew Bailey said on Thursday 8 October, at the Istanbul Economic Forum, that the global financial system remains resilient but faces new long-term challenges from lower growth, repeated supply shocks and changing market structures. 1 Centre · 1The two-day forum was organised by the Central Bank of the Republic of Türkiye and brought together central bank governors and policymakers from around the world. 1 Centre · 2Bailey cited Russia's invasion of Ukraine, the Covid pandemic and the conflict in the Middle East as examples of large negative supply shocks, and said such shocks push inflation and output in opposite directions, which makes monetary policy difficult. 1 2

Centre · 1In a speech prepared for the forum, he said: "Lower growth and repeated supply shocks weaken the public finances while increasing pressure on governments to provide support." 2 Centre · 1He said governments can ordinarily use their balance sheets to cushion a downturn and rebuild fiscal space afterwards, but this becomes much harder to sustain when shocks are frequent, underlying growth is weaker and debt is higher. 2 Centre · 1Bailey said that if markets doubt the path of fiscal policy, government borrowing costs rise; he said it is not a central banker's job to comment on fiscal policy, but that it "must be credible and directed at stability and be seen as such by the markets", and that fiscal rules have an important role. 2

Centre · 1He also said government bond markets have changed profoundly, with leveraged investors now playing a much larger role than traditional long-term investors, which increases capacity to absorb debt but brings greater fragility because deleveraging in one market can spread quickly to others. 1 Centre · 1Among the uncertainties he listed were conflicts in the Middle East, vulnerabilities in sovereign debt markets and asset valuations, and the rapid expansion of AI financing, which he said creates new exposures even though AI could bring growth dividends. 1 Centre · 1He said central banks must make forward-looking judgments and update them as evidence changes, so that temporary shocks do not become persistent inflation, and that strong banks and corporate balance sheets give policymakers room to respond to crises. 1

Centre · 1Bailey called for policies that pursue sustainable growth and credible monetary and fiscal frameworks, and for financial markets to improve their resilience so they absorb future shocks without amplifying them. 1 Centre · 1The Evening Standard noted the remarks come weeks before Chancellor John Healey's autumn Budget, and on a day when the 10-year gilt yield reached about 5.53%, the highest since 2007. 2 Centre · 1EY estimates the Chancellor's fiscal headroom has narrowed from £23.6 billion in March to £11.3 billion, and could be wiped out if the Iran war continues to restrict energy supply, push up inflation and weigh on growth. 2