Bold eh? I’m in an extravagant mood today. Let me explain . . .
The Bank of England has forecast for some time been that inflation would start to fall, and accelerate, as the year went on with a real risk of going far too low. Only a couple of months ago the MPC pumped more cash into the economy to head off this danger.
But in the last few weeks that view has become seriously challenged. Here’s a quick recap: we started the year with inflation standing at 4.2%. January figures saw that drop to 3.6% - big sigh of relief around the MPC table, this is going to plan. February then saw a much smaller fall to 3.4% which raised a few eyebrows - not the nosedive we’d been led to expect – and then of course in March the inflation rate went UP to 3.5%.
Obviously we can’t read too much into one month’s figures, but even so it leaves Sir Mervyn and the gang in a sticky position. The strategy is based on February Inflation Report forecasts that inflation will around 1.6% - 1.8% at the year-end. Dropping about 2% in only 9 months seems a lot to ask at the best of times, but increasingly improbable in the face of February & March figures. Former MPC member Andrew Sentance tweeted (perhaps a little unkindly) “UK Inflation not coming down as MPC expected – yet again! Expect inflation to be stuck around 3.5% for a while.”
On top of which, an unhelpful (for the MPC) footnote in the inflation figures press release said “Budgetary measures that come into force in 2012/13 will add an estimated 0.38 percentage points to the CPI” – which the Bank of England can do nothing about but it certainly isn’t going to help them any.
And – which is the crucial point for my brave prediction – the MPC have started to show they recognise the forecast might be off, and that it’s a problem. On the day the March inflation figures came out, US website forexlive.com quoted arch-dove Adam Posen (of all people!) acknowledging “If core inflation doesn’t come down on a sustained basis then we ought to rethink” - this from the man who voted for more QE as recently as March - and hinting that the minutes of the April meeting would reflect just that.
Indeed they did. Released the next day, the minutes showed Posen had retreated from his QE stance (leaving only David Miles calling for more) and clearly articulating concerns that even mild recovery is likely to give further impetus to inflation. Three specific comments leapt out:
1. That persistently higher inflation could mean the MPC’s “commitment to achieving the target might be called into question,” though some would say that horse hasn’t just bolted, but chained and padlocked.
2. That “This risk [of high inflation] arose from both external and domestic sources”, and
3. That “[the risk of recession] could be attenuated by a more aggressive loosening of policy in the near term. Should the possibility of inflation being above target in the medium term increase, the Committee could subsequently withdraw some of the monetary stimulus.” i.e. raise rates
So we’re no longer holding external factors like VAT and oil prices as entirely culpable, and even those who think the economy may yet need more help, acknowledge that it might have to be unwound again pretty quickly.
What happens then, if we find ourselves in October or November with inflation flat lining around, say, 2.5% - 2.6%? I can’t help thinking that if that’s the case, the Bank will no longer have any option but to start moving rates up. February would be favourite, but you can see them holding out ‘til May in the hopes of a last-minute rescue.
