Bank gets more leeway on its inflation target

 
Tim Wallace
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THE BANK of England will be allowed to let inflation rise higher above target for longer under new governor Mark Carney in order to combat the weak economy, the chancellor revealed yesterday.

And the Bank will be encouraged to indicate the future path of rates to give more certainty to borrowers.

Consumer price inflation is well above its two per cent target but the monetary policy committee (MPC) has been reluctant to raise rates as it would hit growth and raise unemployment.

The change allows the Bank to explain the dilemma in more detail and give markets more information on future action.

Currently the MPC sets rates month by month.

Under the new setup it could fix rates until a threshold is passed – for example when unemployment falls below a given level.

Outgoing governor Sir Mervyn King welcomed the move.

“It is, in my view, a sensible change to previous remits and contains useful improvements to the framework,” he said. “Mark Carney and I have discussed the proposed changes and both support the new remit.”

But economists warned it opens the door for the Bank to let inflation stay higher for longer.

“The chancellor states that in exceptional circumstances when the economy has been hit by large shocks with persistent effects, the MPC should make trade-offs between inflation and output,” said Howard Archer from HIS Global Insight. “This includes taking longer to bring inflation down to its two per cent target.”

Giving information on future low rates could also help push down medium-term interest rates for households and businesses.

WHAT IS CHANGING AT THE BANK OF ENGLAND?

  • The monetary policy committee will be allowed to indicate where interest rates will move in future.
  • It could include promising to keep rates low until unemployment falls.
  • But it also allows the Bank to switch its focus from inflation to growth.
  • The change means inflation is likely to stay higher for longer.
  • The Bank has been following a policy like this for some time, but this change formalises the shift.
  • The move is inspired by action from the US Federal Reserve.
  • The Fed has told markets it will keep printing money until unemployment falls below 6.5 per cent.
  • Tying rates to jobs reduces the emphasis on the inflation target, though the Fed insists it will stop easing or even tighten policy if inflation gets too high.
  • Incoming governor Mark Carney had raised the possibility of abandoning inflation targetting in favour of a nominal GDP growth strategy.
  • George Osborne welcomed the idea of a brief and open debate around monetary policy. This decision appears to mark the end of that debate.