Inflation forecasts stretch credibility

ANALYSTS reacted with incredulity yesterday as Bank of England governor Mervyn King claimed that “temporary shocks” were to blame for persistent above-target inflation and that the Consumer Price Index (CPI) would return to the Bank’s two per cent target before the end of 2011.

This means the Bank once again pushed out the deadline by which it will hit the target, having previously forecast it would do so by the end of this year.

But analysts said that after five years of getting it wrong, the Bank’s projections are testing credibility. Fathom Consulting’s Danny Gabay called King’s explanation for missed forecasts “the Lemony Snicket defence – it’s all a series of unfortunate events. The Bank didn’t come clean about why their forecasts have been so badly wrong”.

And Henderson’s Simon Ward cast doubt on the Bank’s assumption that spare capacity will weigh down on inflation next year: “Again, they wheeled out this argument about spare capacity without taking into account the fact that it has not worked,” he told City A.M..

The Bank’s argument about spare capacity defies some of its own analysis. Explaining why its projections have been wrong, yesterday’s report states: “The recent recession may have had a more immediate adverse impact on effective supply than anticipated, so that a smaller margin of spare capacity has emerged.”