Bank of England Still Targeting 1.8% Inflation
Here is the development of the median forecast curves over the last four quarters:
Similar to the change between February (dark blue) and May (Green), there has been a sharp upward movement to the near-term forecasts but the medium term forecasts remain firmly below 2%.
The above forecasts are based on the market forecast for Bank Rate. I’m not sure if this has happened before, but interestingly, the forecasts based on Bank Rate held constant at 0.5% have lower expected inflation. I presume this is because the market yield curve expects rates to fall to around 0.2% over the next year. In failing to cut the rate the Bank is effectively producing tighter monetary policy than the market expects, and on the Bank’s own forecast model, they are less likely to hit their legal mandate in two years time.
I’m pretty sure the MPC are aware of this, because they keep discussing it and ruling it out – the November MPC meeting minutes:
The Committee also discussed the likely effectiveness of reducing Bank Rate to below 0.5%. Over the past few months, Bank staff had consulted with the FSA and the Building Societies Association on the possible consequences. In the light of that, the Committee had re-examined in detail the desirability of such an option. While it would be beneficial for some existing borrowers, there were concerns that a cut in Bank Rate might prove counterproductive for aggregate demand as a whole. Staff analysis had concluded that a further cut in Bank Rate would be likely to cause a reduction in the profitability of some lenders, especially building societies, because of the prevalence of loans with interest terms contractually or closely linked to Bank Rate. That would weaken their balance sheets and they might have to respond by increasing other loan rates or restricting lending.
Viewed against the backdrop of the Funding for Lending Scheme (FLS), and the potential for building societies to play a material role in increasing lending, the Committee judged that it was unlikely to wish to reduce Bank Rate in the foreseeable future.
There you go: cutting interest rates is bad for aggregate demand because banks might lend less. You couldn’t make it up.