March CPI figures confirm the prospect of another big Bank of England inflation forecasting miss in 2012. The projection here that CPI inflation will finish the year at about 2.75% may now be too low. This projection implies that December inflation will be above the 2% target for a seventh consecutive year, with a cumulative overshoot of 7.5% since the remit was switched from RPIX to CPI at the end of 2003.
The current overshoot, moreover, cannot be attributed to the various “temporary price level factors” cited by the Bank’s Governor in his unbroken sequence of nine explanatory letters since February 2010, just after a speech in which he suggested a looser interpretation of the remit – dubbed here “inflation targeting lite” and judged to represent an effective raising of the target from 2% to 3%.
March CPI inflation of 3.5% was in line with the consensus estimate but follows a significant “upside surprise” in February. The first-quarter outturn of 3.5% compares with a Bank projection of 3.35% in the February 2012 Inflation Report. A year earlier, the Bank expected inflation to be down to 2.86% by the first quarter (mean forecast based on unchanged policy).
The high reading can no longer be blamed on VAT or other indirect tax effects. The CPI excluding indirect taxes – CPIY – also rose by 3.5% in the year to March.
Part of the overshoot is explained by food and energy prices – CPI inflation excluding unprocessed food and energy was 2.9% in March. This boost, however, appears to reflect domestic pressures in these sectors rather than global commodity price developments. The S&P GSCI all-commodities spot index rose by only 1.2% in sterling terms in the year to March, down from 26.2% in the prior 12 months.
The Bank has also previously cited manufactured import price rises related to sterling weakness as a contributor to the inflation overshoot. The pound’s effective rate, however, rose by 1.5% between March 2011 and March 2012.
The February 2012 Report forecast a fall in CPI inflation to 1.87% in the fourth quarter of 2012 and 1.61% in the first quarter of 2013, based importantly on a slowdown in “core” inflation in response to assumed economic slack and better productivity performance. There is little evidence of such a decline in recent data: the CPI excluding unprocessed food and energy, incorporating adjustments for VAT changes and seasonal effects, rose at a 2.9% annualised rate between the third quarter of 2011 and the first quarter of 2012 – see chart.
The forecast here remains that CPI inflation will finish 2012 at about 2.75%, based on a small easing of core price momentum and broad stability of commodity prices and the exchange rate. Recent core resilience suggests upside risk to this projection.
The vanishing prospect of a return to target this year will be a particular disappointment to the Bank’s leading dove, Adam Posen, who, in a Guardian interview in March 2011, predicted that inflation would tumble to 1.5% by the middle of 2012 and stated that: “If I have made the wrong call, not only will I switch my vote, I would not pursue a second term.”