Bank of England policy maker Ian McCafferty said officials should decide whether to accommodate a consumer-price shock from a drop in the pound based on the reasons for the move in the currency.
Were the pound to fall due to “concerns about the MPC’s commitment to price stability, resulting in an increase in inflation expectations, then I strongly believe that the case for accommodation would be much weaker,” he said in a speech in London today. Were the decline to reflect real factors such as rebalancing, “it would not be sensible to prevent the real adjustment by tightening monetary policy.”
Accommodating price shocks is suitable only if that leads to no second-round effects on wages and prices, he said. On a trade-weighted basis, the pound fell 7.1 percent since the start of the year through mid-March, though it has since recovered about half its losses.
The U.K.’s experience with record inflation in the 1970s should remind officials of the consequences of failing to keep expectations for price gains well anchored, he said. The Monetary Policy Committee’s “flexible inflation targeting” -- looking through recent price shocks in favor of supporting the economic recovery -- hasn’t yet dislodged expectations, he said.
“This must not lead us into complacency,” he said. “Recent evidence derived from financial markets has been a little less encouraging.”
The central bank said in its quarterly bulletin published yesterday that expectations risk becoming dislodged because consumer-price growth has been elevated for such a long time. Inflation has exceeded the 2 percent goal every month since December 2009.
“That inflation expectations have remained anchored, and domestic underlying inflation remains modest, is proof that our flexible approach to inflation targeting has not jeopardised our credibility,” he said. “We are well aware that a loss of credibility would effectively amount to a loss of flexibility.”
“It is the MPC’s successful track record of low and stable inflation in the decade that preceded the financial crisis that has given the public confidence in our commitment to price stability,” he said. “We must not take it for granted.”
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