MPC prepared to overlook "period of above-target inflation"
Bank of England dashes hopes of the inflation hawks.
The Bank of England's monthly inflation report confirms that its Monetary Policy Committee is heeding the advice of incoming governor Mark Carney and accepting an "overshoot" of inflation.
Speaking to MPs last week, Carney had confirmed he favoured a flexible inflation target. While he isn't convinced scrapping the target entirely "is a risk worth taking", he stated that he accepts the need for a bit of lee-way on the price target while growth is still below trend.
Today's report from the MPC backs up that argument. The Bank writes:
As long as domestic cost and price pressures remained consistent with inflation returning to the target in the medium term, it was appropriate to look through the temporary, albeit protracted, period of above-target inflation.
Attempting to bring inflation back to the target sooner by removing the current policy stimulus more quickly than currently anticipated by financial markets would risk derailing the recovery and undershooting the inflation target in the medium term.
The MPC’s remit is to deliver price stability, but to do so in a way that avoids undesirable volatility in output.
The key reason for the bank's decision is that it doesn't see GDP increasing quick enough, soon enough, to clamp down on inflation in a way which may damage growth. It predicts GDP returning to positive annual increases, but only reaching 2 per cent annual growth — the barest which could be described as acceptable — in the second quarter of 2014. It also sees a high possibility, although still below 50 per cent, of a contraction in the second quarter of 2013:
As a result, the loosening of the inflation target sans that the bank now doesn't see the rate returning to its two per cent target until 2015:
The news sent the pound down against all major currencies:
But the greater tolerance of inflation only goes so far. The MPC gave no indication that it was inclined to increase quantitative easing, typically seen as a trade-off between growth and inflation in a demand-constrained economy. Whether that means the MPC thinks demand is no longer constrained, or whether its tolerance has limits, remains unclear.