Bank of England reputation at stake in interest rate tragicomedy


Misplaced expectations often lead to a waste of time. Pip, Vladimir and Estragon await Godot, and even the English fans crying for the arrival of Jack Grealish at Euro 2020. These stories teach us that betting on anything can lead to opportunities that go wrong. The Bank of England could be lumped into this group while it waits for inflation to pass.

Monetary policy is largely anchored in two objectives: maintaining price stability and controlling inflation. The Bank’s forecasts for the latter have been wrong lately. Inflation went from 2% to 3.2% in just one month. The Bank expects prices to rise 4% by the end of the year, double its target. The further inflation moves away from the target, the more confidence in the old lady will erode.

Developing a plan for the bond program in the Monetary Policy Committee’s announcement tomorrow would strengthen the muscles of the bank in the fight against inflation. Confidence in continued inflation helps financial markets function well and households and businesses make better purchasing decisions. Expectations about the direction of inflation are partly driven by the integration of the monetary authorities’ own expectations. Thus, producing accurate inflation forecasts helps economies optimize spending.

Inflation forecasts have always been wrong – economists expected the latest figure to be around 2.9%. During the pandemic, they weren’t even close. The Bank was one of the worst offenders. In her May monetary policy report, the old lady beat June inflation by 0.8 percentage point. They believe inflation will be well above target for some time.

Underestimating forecasts increases household and investor expectations for future inflation. Once this happens, it is difficult to catch the tiger’s tail.

In the worst case, workers demand higher wages, investors demand higher returns, and borrowing costs rise. At best, high inflation is ‘transient’.

There is a very real prospect that inflation will be more rigid than what the Bank expects. The OECD has raised its inflation forecast for the UK. According to the Bank’s latest survey of attitudes towards inflation, long-term inflation expectations are on the rise. The British believe it will reach three percent – in five years.

Since the last meeting, the likelihood of a tightening of the bank’s policy has been high. Gov. Andrew Bailey said there was a dead link between the MPC over whether the conditions for a rate hike were met in August. Calls for reduction guidance have grown stronger after the European Central Bank signaled its own plans to tighten up the ship. But a better measure of the Bank’s credibility is its resistance to increased pressure from the markets to do what they expect it to do.

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The UK saw only a small chunk of growth in July. Alarmingly, the output of consumer-oriented companies fell for the first time since January. Retail sales unexpectedly fell 0.9% in August. Struggling pubs and restaurants show that even the big British consumer’s thirst for pints was not enough.

Rising interest rates or substantially reducing bond purchases amid sluggish growth could derail the economic recovery even before output has recovered. Given the base effects that have been driving the spate of high inflation readings lately, it is understandable that the Bank considers some price spikes to be temporary. But, adhering to this judgment requires believing in the rigor of the underlying rationale. Given the Bank’s record on inflation forecasts so far, it’s hard to judge whether it stands up to scrutiny.




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