McCafferty Says BOE Officials Right to Look Through Oil Decline

Bank of England official Ian McCafferty said the central bank is right to look through the temporary impact of cheaper oil on inflation, and there may be less spare capacity in the economy than policy makers estimate.

“The sharp fall of oil prices over the past six months, particularly if sustained in coming months, will depress annual inflation rates for a protracted period –- quite possibly well into next year,” McCafferty said in a speech late on Tuesday in Durham, England. Still, “supply rather than demand has been the dominant factor” and as such will only have a temporary impact on inflation, he said.

Oil’s 51 percent drop since June helped push inflation down to 0.3 percent in January, well below the BOE’s 2 percent target, and officials have said there’s a chance it will turn negative for a short period. Speaking separately on Tuesday, Governor Mark Carney said the impact from lower energy and food prices would be temporary and policy makers intend to return inflation back to their goal within two years.

“The one thing we can’t do, and the thing that would be extremely foolish, is to try and lean against this oil-price fall today,” Carney told lawmakers at a hearing in Parliament. He said policy makers would be vigilant to the possibility that a period of low prices starts to change consumers’ expectations and depresses wage settlements.

Downside Risk

“Some measures of inflation expectations have fallen, but others suggest that inflation expectations remain well-anchored, and there are no signs at present that anything approaching deflationary psychology is likely to take hold,” McCafferty said. “In my view, this downside risk is a relatively low-probability event, but one that would have adverse consequences on the economy, were it to materialize.”

The risks around slack in the economy, estimated by the BOE at 0.5 percent of gross domestic product, being erased by the middle of next year “are probably skewed to the downside,” McCafferty said.

That suggests “there may be less spare capacity left in the labor market, and that the economy could reach effective full employment somewhat earlier,” he said. “As labor-market slack is absorbed, there is a risk that wages may accelerate to a pace inconsistent with stable inflation, which the MPC could not ignore.”

McCafferty was head of Macroeconomics at BP Plc, Europe’s third-biggest oil company from 1998 until 2001. He was then chief economic adviser at the Confederation of British Industry, Britain’s biggest business lobby, until he joined the BOE in 2012.

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