BOE Needs Inflation Target Range to Protect its Credibility, Barclays Says

The Bank of England’s inflation goal should be changed to a target range because the central bank’s need to “turn a blind eye” to faster price increases in the current system erodes its credibility, Barclays Capital said.

The Monetary Policy Committee “sometimes departs from a strict targeting of 2 percent inflation -- and it is this disjuncture that leads to credibility questions,” Barclays Capital economist Simon Hayes wrote in an e-mailed note released today. “It might, therefore, be preferable for the government to specify a target range, for example, 1-3 percent.”

Bank of England Governor Mervyn King said last month that he’s “comfortable” with keeping the target at 2 percent, which inflation has exceeded by more than a percentage point for the past five months. Officials may still keep up emergency stimulus this week to aid the economy’s recovery during the biggest budget cuts since World War II.

“The broader economic circumstances may make the delivery of 2 percent inflation either impossible or excessively costly,” said Hayes, who is a former Bank of England economist based in London. “A target band would, in our view, bring the policy remit more closely in line with both the reality and practice, and as such would be likely to be credibility- enhancing.”

Prices may be more than 4 percent higher than they otherwise would have been by the end of next year because the bank has tolerated above-target inflation since 2008, eroding household incomes, Hayes said. Uncertainty about the future pace of inflation may also destabilize wage negotiations, he said.

“In the near term it is difficult to see an easy solution,” Hayes said. “If the economic recovery proves to be strong, then policy tightening can begin in earnest and the credibility questions will probably go away. It seems more likely, however, that the recovery will be choppy and the MPC will find itself in the uncomfortable position of having to balance the competing risks to price stability.”

The nine-member panel will announce its next monthly decision on Sept. 9.

To contact the reporter on this story: Scott Hamilton in London at shamilton8@bloomberg.net

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