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November 15, 2013 2:15 pm
What people think will happen to prices in the years ahead matters much more to the Bank of England than it did, because of its new “forward guidance” regime, one of the UK’s monetary policy makers has said.
The BoE unveiled its forward guidance on interest rates to markets and the public in August – saying that it would not even consider tightening monetary policy until unemployment fell to 7 per cent.
The framework was ushered in before a batch of better than expected data on the UK economy lessened the need for what chancellor George Osborne called “monetary activism”.
The BoE’s guidance is tempered by three “knockouts”, or clauses that, if breached, require a rethink of the policy.
One of the knockouts commits the MPC to review guidance if medium-term inflation expectations do not remain under control. Martin Weale, the only member of the MPC to vote against the policy in its current guise, said on Friday that this knockout meant people’s expectations of inflation over the next two to three years were now more important.
“Our policy of forward guidance has transformed medium-term inflation expectations, at least for me, from being one of the issues I take into account, to a key influence in the way I vote,” Mr Weale told A-level students at a North London academy.
The external MPC member also said a sharper fall in unemployment than the BoE forecasts at present could warrant earlier-than-expected rate increases, even if inflation stays close to the BoE’s 2 per cent target.
“If unemployment is falling rapidly, we will need to consider the risk of holding rates too low for too long,” he said. “Even with inflation close to target, it is unlikely to be appropriate for rates to remain at their current level until all spare capacity in the economy has been used up.”
The BoE uses a range of indicators to measure inflation expectations. All of the nine cited by Mr Weale showed people think inflation will be above the BoE’s target in the years ahead.
Mr Weale noted that only one measure showed inflation below its series average, though he said that recent high figures could, in part, be because of rises in energy prices.
“It is perfectly possible that this influenced the answers people gave. If that is the case – if the increase is a blip for that or any other reason – then we should expect this indicator to fall back over the next three or four months.”
The surprise dip in inflation to 2.2 per cent in October could also be reflected in people’s expectations in the months ahead, he said.
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