Ahead of the Bank of England's interest rate decision, the governor downplayed the threat of inflation, stating that the second-degree inflation effect remains "relatively mild."

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

In an interview at the Jackson Hole Economic Symposium in the United States on Friday , Bailey said that the UK labor market has remained weak and the effects of second-round inflation have been rather mild. "I think we can continue to observe this situation for now," he said. This was his first public statement on monetary policy since the monetary policy meeting on July 30.

Despite Bailey's dovish stance, market bets on interest rate hikes have clearly intensified. Traders have now fully priced in a 25 basis point rate hike this year and are betting on another hike next spring, with short-term UK government bonds underperforming comparable US Treasury bonds.

At the same time, committee member Catherine Mann warned at the summit of the potential impact of US spillover effects and the rising dominance of the dollar on the transmission of British monetary policy.

Bailey maintained an observer stance, rejecting expectations of interest rate hikes.

Bailey's statement is a continuation of his public pronouncements following the July interest rate decision. At that time, he voted 6-3 to keep the interest rate unchanged, and in the subsequent press conference, he explicitly stated, "Please don't leave this room thinking that the Bank of England is moving toward raising interest rates."

In Jackson Hole, Bailey reiterated this tone, noting that the current second round of inflation is "quite mild" and the labor market has continued to weaken. He also emphasized that the BOE is assessing policy on a case-by-case basis and remains cautious about forward guidance.

"The problem with forward guidance is that it tends to make unconditional statements about policy, which is dangerous," Bailey said, echoing the views of Federal Reserve Chairman Warsh at the same event.

Inflation data diverges from labor market data

Currently, the core driver of rising market expectations for interest rate hikes is the strengthening of inflation data. The latest UK CPI data shows that inflation has rebounded for the first time since March, with rising energy prices triggered by the conflict with Iran being the main driver.

A consumer confidence survey showed that in August, residents' expectations for price increases over the next year rose to 3.9%, roughly double the BOE's target.

Meanwhile, European Central Bank officials have also leaned towards a second interest rate hike since the conflict began, with eurozone inflation remaining around 3% amid stronger-than-expected economic growth. The protracted conflict between the US and Iran is increasing the risk that the global energy shock will evolve into a broader inflation crisis.

However, signals from the UK labor market are clearly diverging from inflation trends. Businesses are laying off workers, job vacancies have fallen to a five-year low, and private sector wage growth continues to slow. Bailey points out that these factors support his cautiously optimistic assessment of a second-round effect, but at the same time admits: "I cannot promise that this situation will continue."

Commissioner Mann warns of new risks posed by dollar dominance.

The BOE is not a monolithic entity. Catherine Mann, a minority member who voted to raise interest rates in July, warned of spillover effects from the United States in an interview in Jackson Hole, and later focused on the deeper risk of the rising dominance of the dollar at the summit.

"The implication from a monetary policy perspective is that the transmission of monetary policy may face potential weakening," Mann said. She pointed out that the geopolitical and institutional erosion of the pound relative to the dollar is making it more difficult for the BOE to regulate the UK economy.

Mann's statement contrasts sharply with Bailey's tone, revealing deep divisions within the BOE policy committee regarding the pace of interest rate hikes and external risk assessments. As the September 17th decision approaches, market bets on the BOE's policy path are expected to continue to diverge.

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