The Bank of England changes its inflation stance

The latest Bank of England Inflation Report shows the Old Lady resigning herself to more inflation.

In recent years the Bank of England (BoE) has gained an unfortunate reputation for over-optimism about the path of inflation. The BoE’s Quarterly Inflation Reports (QIRs) have regularly said that inflation would be back on target (2% of the consumer prices index [CPI]) by the end of its two-year forecast period. Each quarter’s bulletin has contained a graph which, almost magically, showed the chances of inflation being above target were 50% two years out. However, CPI inflation has been over 2% since December 2009 and has only been below 2% for six months in the last five years, and reached a peak of 5.2% as recently as September 2011.

The BoE’s latest QIR, the penultimate of Sir Mervyn King’s tenure as Governor, has changed tack somewhat. The February edition says that ‘Inflation has remained stubbornly above the 2% target…CPI inflation is likely to rise further in the near term and may remain above the 2% target for the next two years.’ The graph now shows a near 60% probability that inflation will be over 2% in the first quarter of 2015, with the 50% level not being reached for another year.

The BoE’s new inflation sangfroid is a reflection of the state of the economy and government finances.

  • In normal times, above-target inflation would mean that the BoE would increase interest rates. However, the parlous state of the UK economy rules out such a course of action. Rate rises and the threat of a triple-dip recession are not compatible.
  • Some of the inflationary pressure is the result of Government policy, which the BoE is powerless to counter.  The QIR comments that moves such as increases to tuition fess and green levies on energy suppliers added around 1% to inflation at the end of 2012 and are likely to continue to add to it.

The message of the BoE’s new stance is that, at least for now, inflation is less of a concern than helping the economy by keeping interest rates low and taking other monetary action, such as quantitative easing. That is not good news if you hold large sums on deposit.

15th March 2013