Today's decision by the Bank of England to keep bank rate at its historical low of 0.5% was not much of a surprise, given Governor Mervyn King's defence of the Bank's dovish stance in his recent speech in Newcastle. However, the vote on the nine-person MPC may have been a close-run thing -- two members voted for a rate rise in January, and the inflation picture has only worsened since then.
Worryingly for the Bank, more and more commentators are expressing concern that the Bank's hard-won credibility as an inflation fighter is being put at risk. Trade organisations like the CBI have welcomed today's decision, but media commentators are becoming a lot less confident that the Bank knows what it is doing. A quick look at the Bloomberg ticker suggests that the only acceptable adjective to describe UK inflation is now "soaring".
This particular Bloomberg story, written after the rate decision, is especially interesting. Bloomberg has sought out reactions from two former MPC members, DeAnne Julius and Ruth Barker -- and both think the Bank is getting it wrong:
Julius said yesterday that the Bank of England must raise its rate “sooner rather than later” to prevent rising price expectations from getting entrenched in the economy, and said an increase in May is likely. Barker said last week the bank’s tolerance of a prolonged bout of above-target price gains has cost it a “modest loss of credibility.”
It's a while since either of these worthies was on the MPC, but if memory serves, they were always among the more dovish members of the Committee, which adds to the significance of their present views.
The Bank argues that it is "looking through" a seemingly endless string of "one-off" inflationary shocks: soaring commodity prices, rising energy prices, food crop failures, the VAT increase. It's by no means alone in this. The US Federal Reserve is doing much the same thing. That doesn't make it right, though. The logic of "looking through" shocks like this is that they represent relative price adjustments rather than true inflation, which is an upward ratcheting of the overall price level. The Bank (and the Fed) are assuming that as these shocks pass through the system (or at least pass out of the CPI calculation, in the case of the VAT increase), inflation will quickly retreat to more comfortable levels.
There are two possible problems here. The first and simplest is that the Bank has been expressing that hope for quite some time, and it hasn't happened yet. CPI was supposed to move back to the 2% target this year. It's currently at 3.7% and heading higher, with the Bank now forecasting (or maybe praying for) a return to target in 2012. The second and more profound point is that the whole notion of looking through one-off shocks may soon be tested to breaking point. It's one thing to expect price shocks to subside when monetary conditions are in some sense normal; it's quite another to count on it happening when monetary conditions, both in the UK and globally, are extremely loose. It's far from clear that the economy is anything like weak enough to stop inflation expectations and wage demands from getting out of hand, at which point the Bank would have a big problem on its hands.
I realise that as a retiree, I'm talking my own book here, but it seems to me that the UK economy would be better served by a slightly tighter monetary stance and a slighly looser fiscal stance than is currently on the cards. Under current arragmenets, though, there's no obvious way of making that change. It almost makes you pine for the pre-1997 days when the Chancellor had the last word on interest rates as well as fiscal policy.
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