CPI inflation is expected here to fall further through early 2014, undershooting the MPC’s forecast significantly, before rebounding later next year and in 2015 in lagged response to recent monetary buoyancy and associated economic strength. The near-term decline may allow the MPC to claim that the “inflation-growth trade-off” (a questionable concept) is more favourable than it had assumed, implying that Bank rate can be held at 0.5% even if the unemployment rate falls well below its (current) 7% threshold.
CPI inflation eased from 2.8% in July to 2.7% in August, while the core measure monitored here – which excludes energy and unprocessed food and adjusts for changes in VAT and undergraduate tuition fees – was stable at 2.0%. The core rate has trended lower since early 2012 in lagged response to a slowdown in monetary growth in 2010-2011 – see previous post for details.
The core downtrend is scheduled to continue into the autumn and may be reinforced by recent sterling strength. Coupled with smaller rises in energy and unprocessed food prices than a year before, this may result in CPI inflation falling to 2.25-2.5% in early 2014 versus a current MPC central projection of 2.89% for the first quarter of next year.
Core inflation, however, is forecast here to embark on another upswing from late 2013 in lagged response to a sustained pick-up in monetary growth from late 2011. Incorporating assumptions about energy and food prices detailed in the prior post, this implies that CPI inflation will move significantly higher from spring 2014, probably exceeding 3.0% during the second half of next year. The first chart below shows projections for headline and core inflation while the second compares the former with the MPC’s forecast.
The suggestion is that the MPC’s policy stance will be exposed as having been much too accommodative in mid-2014, with the unemployment rate at or close to the 7.0% threshold and inflation rebounding strongly. Monetary conditions may then be tightening in response to higher market yields and as faster inflation squeezes real money supply growth. Belated hikes in Bank rate would not prevent a further rise in core inflation in 2015 – already baked into the cake by recent monetary trends – but would increase the probability of another economic downswing in 2015-16.
Such a scenario would imply that, by failing to respond in a timely fashion to monetary signals, the MPC has once again served to magnify rather than moderate underlying economic volatility. Such mismanagement, in turn, deters businesses from making the investment commitments needed to boost long-run potential growth.
