Bloomberg News

U.K. Inflation Expectations Risk Getting Dislodged, BOE Says (1)

June 13, 2013

Chancellor of the Exchequer George Osborne

Inflation has exceeded the BOE’s 2 goal target every month since December 2009, and Chancellor of the Exchequer George Osborne revamped its mandate in March to give it more flexibility to set policy. Photographer: Simon Dawson/Bloomberg

U.K. inflation expectations risk becoming dislodged because consumer-price growth has been elevated for such a long time, Bank of England economists said.

“The prolonged period of above-target inflation could cause inflation expectations to become less well anchored,” the researchers wrote in an article in the central bank’s Quarterly Bulletin, published in London today. “That could trigger changes in the nominal exchange rate, and affect consumption and investment decisions, as well as wages and prices, and could cause inflation to persist above the target for longer.”

Inflation has exceeded the BOE’s 2 percent target every month since December 2009, and Chancellor of the Exchequer George Osborne revamped its mandate in March to give it more flexibility to set policy. While “most indicators are consistent” with expectations remaining anchored to the target, risks have developed, the report said. A quarterly BOE survey published last week showed no change in expectations in the coming year from the first quarter.

Higher energy costs, import prices, value-added tax and regulated prices have largely pushed up consumer prices, prompting the Monetary Policy Committee to judge it “appropriate to look through the period of above target inflation,” Becky Maule and Alice Pugh of the bank’s Monetary Assessment and Strategy Division wrote in the article. The lack of movement in most measures of inflation expectations suggest wage growth and inflation haven’t yet been affected.

Still, “there is tentative evidence that financial market measures of inflation expectations have become a little more responsive to developments in the economy,” the officials said.

Policy Decisions

The MPC will continue to “monitor and assess” this data, which remain “an important factor” in policy decisions, according to the article.

Higher levels of uncertainty since the financial crisis started may also continue to curb consumer spending and investment, and may be a factor restraining the economic recovery, according to a separate chapter in the bulletin.

“Uncertainty has remained relatively elevated over the past five years,” said Abigail Haddow and Chris Hare of the bank’s Conjunctural Assessment and Projections Division, John Hooley of the Bank’s International Finance Division and Tamarah Shakir of the Bank’s Macroprudential Strategy Division. “Considering different strands of theory and evidence on how households and companies respond to uncertainty suggest that, as long as it remains elevated, some restraining effect on the level of consumer spending and investment may continue.”

Dissatisfaction

Michael Goldby of the Bank’s Monetary Assessment and Strategy Division noted in another article that “satisfaction with the way in which the bank has set interest rates to control inflation remains much lower than before the financial crisis.” He said “net satisfaction, while remaining positive over the past year, fell to a series low in 2012 in the third quarter, before recovering a little in subsequent surveys.”

A separate article suggested that while cross-border capital flows provide considerable benefits by diversifying lending sources, BOE analysis has shown they “exacerbated the bust once the crisis hit.” The writers said that policy makers must monitor these flows from a domestic and international level, and officials may need to consider new policy mechanisms to achieve this, such as former international foreign currency liquidity arrangements.

A chapter on the Funding for Lending Scheme, which the central bank and the Treasury extended in April by a year to get credit to smaller companies, noted that feedback from market participants on the plan’s extension had been positive.

“The bank expects that a significant number of eligible banks and building societies will sign up to the extension,” according to the article.

To contact the reporters on this story: Svenja O’Donnell in London at sodonnell@bloomberg.net; Jennifer Ryan in London at jryan13@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net


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