BoE Governor Bailey says policymakers should strengthen core financial markets so they can absorb future shocks without amplifying them; monetary policy needs an unwavering commitment to returning inflation to target

INFLATION The conflict in the Middle East has created major uncertainty about growth, inflation and interest rates. But looking through a shock is possible only if inflation expectations remain well anchored. If households and businesses begin to incorporate higher inflation into wage demands and pricing decisions, a temporary shock can become persistent. A recent history of higher inflation can cause people to expect further inflation. For monetary policy, that means an unwavering commitment to returning inflation to target. ECONOMY Lower growth, repeated supply shocks and changing market structures mean that resilience cannot be taken for granted. We should therefore prepare for a world in which larger shocks are not rare exceptions. Artificial intelligence and robotics can drive scientific discovery, improve efficiency and raise prosperity. RATES / MONETARY POLICY The textbook response is to look through a one-off increase in the price level. Interest rates cannot produce more oil or gas, and monetary policy affects the economy with long lags. Central banks must make forward-looking judgements and update them as the evidence changes. Interest rates may need to rise even as economic activity weakens. I remain sceptical of unconditional promises about future interest rates. FINANCIAL STABILITY / BOND MARKETS Banking systems generally remain well capitalised and we are not seeing funding stress. Financial markets have so far withstood significant increases in sovereign bond yields, and most market adjustments have remained orderly. If markets begin to doubt the fiscal trajectory, bond yields can rise further, tightening monetary and financial conditions. Today, leveraged investors play a much larger role, while traditional demand for long-duration debt has declined, partly because of changes in pension provision and ageing populations. But greater absorption has come with greater fragility. Deleveraging that begins in one market can therefore spread quickly to others. AI But greater financial exposure to AI also creates risk. If earnings expectations or confidence in the pace of AI adoption were sharply revised, the consequences could spread through equity, credit and sovereign markets. AI safety and financial stability are therefore becoming increasingly connected.