Bank of England Targeting 2.3% Inflation
I had no time to post last week, and there is a lot to write about.
The forecast data from the February Inflation Report is out. The CPI forecasts have been revised upwards right across the forecast period, particularly sharply in the near term. Here’s how the forecasts have developed over the last four quarters:
The Bank is for the first time since 2008 forecasting CPI inflation significantly above 2% on the two year horizon – 2.3% to be exact.
We can split out the forecast on the two and three year horizon for context. Each point on this chart gives the contemporary forecast looking two years (blue line) and three years forward (green line):
This is a sharp move upwards on the two year horizon. Why? Over to the February MPC minutes:
25. Inflation was likely to rise further in the near term and could remain above the 2% target for the next two years, reflecting sterling’s recent depreciation and the persistent contribution from administered and regulated prices. That persistent contribution was likely to be increasingly offset by a gentle moderation in domestic cost growth, aided by a gradual revival in productivity growth, and an easing in external price pressures, such that inflation was likely to fall back to around target by the end of the forecast period. The outlook for inflation over much of the forecast period was higher than in the November Inflation Report, reflecting the impacts of administered prices and the lower exchange
What is more interesting is that no less than three MPC members (King, Fisher, Miles) voted for an extension of QE at the February meeting despite this forecast for CPI above 2%.
This seems like quite a shift in the Bank’s reaction function. It is worth contrasting February 2013 with May 2012 when MPC hawks were on the rampage despite below-target CPI forecasts, or Spring 2011 when the MPC came close to a rate hike with the CPI forecasts were roughly on target.
Or we could go back to early 2010, when the MPC did not try to offset the supply-side price shock when Darling allowed VAT to return to 17.5%, stopping the original QE programme in January that year as this took effect. The MPC could easily have used this same type of “administered and regulated prices” excuse to ensure the VAT rise did not compress net prices below 2%. Instead we got CPI at constant taxes rising just 1.5% in 2010. (Memo to Ed Balls: it is hard to imagine a worse way to try to boost UK aggregate demand than hoping the MPC plays along nicely both after and during a temporary VAT cut.)
It’s welcome that UK monetary policy is becoming less tight, but it should be clear that this is another example of monetary discretion not monetary rules.