Climate policy is likely to be more inflationary than expected, a Bank of England deputy says
- Sarah Breeden said a sharp rise in carbon costs could keep inflation high
Policies to combat climate change have “probably” had a greater impact on the inflationary turmoil of recent years than expected, the Bank of England’s deputy governor has said.
Sarah Breeden, who is responsible for the bank’s financial stability efforts and is a member of the Monetary Policy Committee, said in a speech on Friday that a sudden sharp rise in carbon costs due to British policies could keep inflation elevated for longer.
Russia’s invasion of Ukraine in 2022 was the crucial catalyst in an inflationary spiral led by energy prices, pushing the UK consumer price index up to 11.1 percent in October that year.
Breeden told an audience at the University of Edinburgh’s Business School that the rise in wholesale gas prices coincided with a ‘material’ rise in carbon costs.
This, she said, was driven by a reduction in the supply of carbon permits, a falling number of free permits issued and “an expansion of sectoral coverage” under the UK emissions trading scheme.
Carbon permits, also called carbon credits, can be purchased by companies and individuals to offset carbon-emitting activities.
Cost of carbon: Bank of England Deputy Governor Sarah Breeden
The ETS sets a limit on the total amount of certain greenhouse gases that may be emitted by the sectors involved.
It meant that carbon prices roughly doubled to around £100 per tonne of carbon dioxide equivalent by summer 2022.
Breedon said: ‘These carbon costs are non-trivial in the sectors most exposed to the plan, such as the energy sector.’
She explained that while wholesale gas prices were the dominant driver of high electricity prices in 2022, carbon costs, which amounted to around 50 percent of fuel costs for gas-fired electricity generators, were “a major driver of prices.”
The Bank of England compared the impact of the gas supply shock with the carbon permit supply shock
Breeden said: ‘The source of an energy price shock could influence its impact on inflation.
‘Specifically, if energy prices rise due to a supply shock for carbon permits, the impact on non-energy price inflation could be around 1.5x greater at peak – and last several months longer – than if the increase were caused by a gas supply. shock.
“That seems plausible if these types of shocks are expected to last longer, given the stringency and scope of the carbon licensing system is expected to increase over time.”
‘New shocks’ to the economy are not so bad
Breeden added that the BoE must “build more sophisticated climate policy analysis into its day-to-day monetary policy,” highlighting “mounting evidence that this matters for price stability.”
It came as the deputy governor, who is planning a wider speech on the impact of climate policy ‘later this year’, outlined her near-term economic outlook.
Breeden, who has been with the bank since 1991, said she expects “a continued unwinding of previous shocks as lower headline inflation gradually translates into lower wage growth and this eases pressure on price setters to pass on higher labor costs into the prices’.
She warned that there are “new shocks” hitting the economy, such as the labor market impact of the Autumn Budget, but said “these are likely to be significantly smaller than the major shocks of the recent past”.
This suggests the Bank of England is willing to consider resuming interest rate cuts if inflation eases, after pausing at 4.75 percent amid fears of a revival in price pressures.
Breeden said: “The recent evidence further supports the case for repealing the restrictiveness of the policy and I expect the restrictiveness to be gradually removed over time.
‘The important questions as I look ahead are what combination of shocks will explain the recent slowdown in activity and how employers will respond to higher labor costs.
“The answers to these questions will influence the medium-term outlook for inflation and therefore the speed at which restrictiveness should be lifted.”
DIY INVESTMENT PLATFORMS
A. J. Bell
A. J. Bell
Easy investing and ready-made portfolios
Hargreaves Lansdown
Hargreaves Lansdown
Free fund trading and investment ideas
interactive investor
interactive investor
Invest for a fixed amount from € 4.99 per month
Sax
Sax
Get £200 back in trading fees
Trade 212
Trade 212
Free trading and no account fees
Affiliate links: If you purchase a product, This is Money may earn a commission. These deals have been chosen by our editors because we believe they are worth highlighting. This does not affect our editorial independence.