A quick Bank of England Inflation Report Press Conference Post Mortem.
The headline seems to be that MPC is forecasting a larger, protracted deviation of CPI inflation below the 2 per cent target. That is despite some softening in the yield curve, which we could think of the MPC as validating, between August and November’s report.
Yet the MPC last week decided to leave current Bank Rate rates at 0.5% and QE assets at £375billion, and do nothing else.
A weakening in the outlook that leads to a larger and more protracted deviation of goal variables from target should prompt some loosening, unless there is good reason not to.
One reason might be that other concerns – real activity, unemployment – have improved. But they haven’t. The MPC isn’t trading off a larger inflation deviation against something else.
It’s possible that the MPC views particularly small changes in the outlook as not worth responding to at all, perhaps because continual adjustments to its instrument-settings would look like incompetence, or spurious fine-tuning. But if that was the case, the initial launch of forward guidance ought to have been ruled out, which at that time seemed designed to reverse a marginal increase in long rates.
In principle, it might be possible that the MPC perceives there to be a change in the likely fiscal stimulus that would compensate for the weaker outlook, requiring no more action from itself. But that doesn’t seem to be the reason either, nor plausible. There is only fog about what the fiscal stimulus will be beyond the election date.
We could infer that the MPC doesn’t view a tactic of trying to talk longer rates down further as effective or productive. If so, why? What’s changed about their view of future interest rate management since they last thought it necessary to guide longer rates down?
We could also infer that the MPC views QE as ineffective, or that further QE would be a net cost to the economy. Yet that doesn’t chime with the policy of continuing to reinvest proceeds of maturing assets in the meantime, nor with other words about QE uttered along the way.
There’s also the possibility that MPC could cut rates below 0.5%. Is it really the case that the UK is so different from the EZ or the US that we have to have a higher floor? Are the factors that weighed against a lower floor still material? Have all the new MPC members that have come on board since that floor was set studied the evidence on that floor and concluded that they are also signed up to it? Why doesn’t the prospect of an increase in the below-target deviation of inflation warrant reviewing this evidence?
At the chosen floor for the conventional instrument, a worsening in the outlook should, other things equal bring about a disproportionate loosening in order to avert the risk of being trapped there for a long period, inducing damaging deflation. The MPC seem to have chosen to be disproportionately passive, without an especially compelling reason. When Carney arrived, he seemed determined to ‘secure the recovery’ as he put it, and particularly averse to signs that progress in doing so had stalled. Now, there is no percetible response to this worsening in the outlook. Although the positive growth seen since then is cause to be more relaxed about peturbations from the path back to the inflation target, the passing of more time trapped as the interest rate floor is cause to be less relaxed.
Of course, the forecast has one thing going for it: one certainly cannot accuse the MPC of reverse-engineering the forecast to make it justify the policy decision, as I described them doing in years past.