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Climate change represents a growing threat to the UK’s economic stability, with the potential to worsen inflationary shocks and trigger the sudden repricing of assets, a top Bank of England official warned on Thursday.
Sarah Breeden, the BoE’s deputy governor for financial stability, said risks that once seemed “hypothetical or far off in the distance” were now ones “that could materialise, and in some cases already are materialising” within the time horizons considered by policymakers.
She pointed to a growing body of evidence that extreme weather events push up inflation through supply shocks that central banks find difficult to deal with — with temporary price surges creating a risk of lasting changes in households’ expectations and behaviour.
Without adaptation, global food price inflation could increase by 1 to 3 percentage points by 2035, adding between 0.3 and 1.2 percentage points to headline inflation, research by the European Central Bank has shown.
The BoE estimates that policy-driven changes in carbon prices accounted for a full percentage point of the increase and subsequent fall in UK inflation in 2021-23 — a period where the headline rate of consumer price inflation peaked above 11 per cent.
Energy and food prices, which are central to household budgeting, have “outsized” effects on people’s expectations of inflation and on price and wage setting, Breeden noted. That made it essential for monetary policymakers “to understand the economic impact of these climate shocks and be ready to react as needed”.
Breeden’s remarks echo warnings by other central banks that climate shocks are becoming an immediate threat to economic stability — with the ECB this week highlighting scenarios showing that a series of extreme weather events could cut GDP by 5 per cent by 2030.
Her speech follows criticism of the BoE for scaling back its work on climate change, which has become less of a priority following a change in its remit by government, and the departure of its former governor Mark Carney.
In May, Breeden warned the BoE should “stay in its swim lane” when tackling the financial risks of climate change, staying away from political decisions on how to reach net zero and focusing on making sure financial institutions are equipped to manage climate-related risks.
She warned an audience of commercial property executives on Thursday that current pricing in corporate and sovereign bond markets did not fully reflect the risks of climate events triggering inflationary shocks to the economy that would lead to sharp changes in interest rates.
“Rapid repricing could occur if markets start pricing in severe physical climate risks or a disorderly transition,” she said, adding that big institutions outside the banking sector “might not be resilient” to the resulting drop in sovereign bond prices.
