Bank of England’s inflation over-optimism must now end

Allister Heath
EXCUSES, excuses, excuses. Once again, the Bank of England has suffered the humiliation of seeing consumer price index (CPI) inflation increase, rather than drop, last month. The CPI measure increased from 3.4 per cent to 3.5 per cent; let’s never forget that the target that the Bank is meant to be sticking to is two per cent and that if it moves one per cent either higher or below that the governor is forced to write an open letter to the chancellor. There have now been nine of these letters in a row, starting in February 2010. The Bank’s record over the past few years has been poor, even though it has tried to deemphasise its core inflation-busting target.

Now, don’t get me wrong: of course, the situation is not as bad as it previously was and inflation is lower. Price rises will probably dampen a little more as the year progresses. But my beef is that – once again – the Bank has been shown to be too optimistic, with no consequences. It is almost unthinkable that it will be back or even below target by the end of the year, until recently the line peddled and amplified by the many doves in the City. Inflation on the CPI measure in the first quarter as a whole was 3.5 per cent (the same as for March alone): this was higher than the official Bank projection of 3.35 per cent made as recently as its February 2012 Inflation Report. In February 2011, the Bank expected inflation to be down to 2.86 per cent by the first quarter (on the mean forecast of unchanged policy). Adam Posen, the MPC’s arch-dove, said in an interview in March 2011 that inflation would tumble to 1.5 per cent by the middle of 2012. As he put it, defending his support for continued low rates and greater quantitative easing: “If I have made the wrong call, not only will I switch my vote, I would not pursue a second term.” A miracle could still happen – but it will be interesting to see how that pans out.

It is key to understand why inflation is rising. Simon Ward of Henderson demolishes three excuses: it wasn’t tax. The CPI excluding VAT and indirect tax went up by exactly the same as the overall index. Food and energy prices were a driver – but remarkably, much of this was domestic in origin, not imported from overseas. The killer fact here is that the S&P GSCI all-commodities spot index rose by only 1.2 per cent in sterling terms in the year to March, down from 26.2 per cent in the prior 12 months. It wasn’t the weak pound either: sterling’s effective rate rose by 1.5 per cent between March 2011 and March 2012. The problem is excessively loose monetary policy.

Candidates for the job of next governor should explain how they will do a better job of fighting inflation – or if they believe that higher inflation is on balance a good thing (a flawed idea) explain why they think the target should be diluted. But the current charade – year after year of over-optimistic forecasts, often wildly so, followed by anodyne letters to the chancellor and an equally useless reply simply won’t do any more.

Britain is plagued both with an ineffective and confused monetary policy and an equally over-optimistic fiscal policy. Regarding the latter, the current austerity until 2017 is just the start. The IMF made it clear yesterday that massive age-related and healthcare timebombs will require an 11.3 per cent tightening by 2030.

There is little hope of a real acknowledgment of the true scale of the fiscal disaster; but there is at least some hope that the monetary confusion could be tackled. The best way to start is for the Bank’s next letter to the chancellor to be much more detailed, and for George Osborne to reply properly. It’s time to get a grip.