Home > Monetary Policy > Bank of England Targeting 2.3% Inflation

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:

Bank of England: Median CPI Forecasts

Bank of England Median CPI Forecasts

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):

Bank of England: Median CPI Forecasts on Two, Three Year Horizons

Bank of England: Median CPI Forecasts on Two, Three Year Horizons

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.

Categories: Monetary Policy
  1. SK
    February 27, 2013 at 10:34

    And the real inflation for low/middle incomes is much much higher.

    But the BoE is looking through it and this way ignoring growth..


    • February 27, 2013 at 10:58

      Ah, yes, the Internet Austrian’s favourite… “real inflation” is really high, because we can find always find SOME prices going up. And the central banks should always fight price rises… if they can find it somewhere, anywhere.

      House prices going up? That’s the real inflation hurting real people! Monetary base going up… that’s the real inflation hurting real people! VAT going up? That’s the real inflation hurting real people. On it goes.

  2. February 27, 2013 at 13:04

    I find it hard to believe that “real inflation” is much higher than the CPI when “median inflation” is much lower than the CPI.

    In fact everything puzzling about the UK’s macro economics goes away if you assume that “real inflation” is much lower than the CPI. Then GDP would be higher, bringing the jobs picture and the GDP picture into alignment. It also makes more sense of the bond market. More sense of the productivity stats (which would be revised upwards).

    Looking at the price level is particularly foolish in a small island trading economy like the UK. When our exchange rates fluctuates so do the prices of goods. As a major international currency, the pound has fallen nearly 50% vs the euro in 2000, because the euro was absurdly undervalued and the pound benefited from haven status, and now because of the ECB’s absurd hard money status. This will always add a lot to those goods that we import. E.g. Food. Sooner or later the pound will rise again and inflation will fall and those sectors will go into deflation.

    I have been thinking a lot about better measures of inflation. Maybe I will post on it later.

    • February 27, 2013 at 13:08

      Thanks for your comment, worldofinterest. And I really liked your post last year on CPI measurement.

      I don’t know whether the ONS actually use the whole CPI index to deflate any portion of NGDP, though. I suspect (hope) they cannot use the CPI-including-tuition-fees to deflate household consumption spending. It would be quite meaningless. I might ask them.

  1. March 1, 2013 at 12:21
  2. May 17, 2013 at 08:02

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