OPINION - Stephen King: Has the Bank of England learned nothing from its errors on inflation?
How many times over the past two years has the Bank of Englandforecast a significant, lasting problem with inflation? The answer is “never”. Yes, the Bank is prepared to accept that inflation might be rather punchy at any one moment in time. The Bank will even acknowledge that inflation might still be rather high 12 months down the road. But in two years’ time? Never.
This longer horizon is important because the Bank believes the full impact of interest rate decisions made today will only be felt in two years’ time. All sorts of random events can affect inflation in the near-term term – Covid-related supply shortages, invasions of neighbouring states by malevolent forces – but over the longer term, it’s monetary policy that matters.
There is, however, a rather obvious problem with this approach. The Bank, it seems, can never be wrong. Indeed, its own projections — based on financial market expectations of future policy rates — mostly confirm as much. Inflation will only stray from the Bank’s two per cent target if either, first, the Bank itself thinks those financial market projections are wrong or, second, there is unforeseen random future inflationary “noise”.
Consider, for example, the Bank’s inflation forecast made in November 2020. Back then, the Bank thought inflation today would be — you’ve guessed it — two per cent. Six months later, by which time actual inflation was on the rise, the Bank’s two-year-ahead forecast was — again — two per cent.
Despite the relentless further acceleration of actual inflation since then, the two-year-ahead forecast has remained stubbornly at around two per cent. Until now, that is. In its November 2022 Monetary Policy Report, the Bank forecast an inflation rate two years from now of only 1.4 per cent before heading to 0.0 per cent at the end of 2025.
Admittedly, the Bank publishes a “fan chart” of possible inflation outcomes around this “central projection”. Central bank infallibility, it turns out, is not quite papal. The message, however, is clear. While inflation is currently too high, it will be too low if policy rates rise as much as investors currently expect.
You might think it perverse that, in a world of excessive inflation, the Bank is more fearful of an undershoot than an overshoot of its inflation target. You might even wonder why the Bank is convinced that policy rates won’t rise as much as investors fear, given the inflationary overshoots seen to date.