Bank of England Is Right to Ignore Inflation
The U.K. economy is in a holding pattern after the June referendum decision to quit the European Union. Growth hasn't collapsed, consumers are still spending, and the Bank of England kept its monetary policy unchanged on Thursday.
And while Governor Mark Carney says future moves could be in "either direction," it's pretty clear that inflation would have to accelerate dramatically to prompt the central bank into raising rates anytime soon.
The bank upgraded its forecasts for growth and inflation, the second time it has revised the outlook since the Brexit vote. Even though some members of the Monetary Policy Committee said they're moving "closer to their limits" on allowing consumer prices to rise by more than the bank's 2 percent target, history suggests policy makers are used to taking a relaxed attitude to price gains:
Traders have increased their bets on higher U.K. borrowing costs in recent months; but they pared those expectations in the wake of Carney's Thursday comments, with less than a 50 percent chance that the central bank's benchmark rate will be above its current 0.25 percent level in a year's time:
There's one overriding reason why the Bank of England is correct to ignore the inflation overshoot -- stagnant wage growth. Projections from the Office for Budget Responsibility show that Brits face a pay squeeze in the coming year as that rise in inflation eats into pay increases:
Moreover, the central bank published a chart in Thursday's inflation report that shows it has consistently overestimated how much average wages would increase, erring by as much as 1.5 percentage points in recent years:
With an unemployment rate of less than 5 percent, there might be a risk that workers feel empowered to demand higher wages in response to rising prices. But Bank of England Deputy Governor Ben Broadbent said he doesn't see that happening. If the inflation was being domestically generated, companies would have more income from those higher prices to pay higher wages, he said; instead, the pound's tumble since the June plebiscite is responsible for pushing up inflation by making imports more expensive.
"If we do see a situation where there is faster growth and wages than we anticipated or spending doesn’t decelerate later in the year, one can anticipate there would be an adjustment of interest rates," Carney said.
That seems unlikely, given the OBR's projections. The last thing British consumers will need as rising consumer prices erode pay increases is higher borrowing costs. The Bank of England would be wise to allow inflation to exceed its target -- and that relaxation may need to last for the next few years, for as long as the U.K. is focused on working out what the post-Brexit trading landscape looks like.
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