The Bank of England reveals it is an inflation creator rather than targeter

Yesterday Bank of England Governor Mark Carney spoke at the ECB summer conference in sunny Sintra Portugal. Tucked away in a speech mostly about the Euro was a reference to the problems the Bank of England has had with inflation as you can see below.

While the euro area has continued to experience ‘divine
coincidence’ the UK has not (Chart 1). In the euro area, inflation has averaged half a point below target,
reflecting in part the drag from persistent slack in the labour market. In contrast, UK inflation has been above
target, averaging 2.3%, during a period where the economy was operating well below potential.

Over such a period that is quite a difference and for the moment I will simply point out that he has no idea about the “potential” of the UK economy as his speech later inadvertently reveals. But let us move on to his explanation.

That reflects the inflationary impacts of two large exchange rate depreciations and weak productivity that have
offset a major positive shock to labour supply. This has created tensions between short-term output and
inflation stabilisation in the UK that have not been evident in other major economic regions.

Missing from his explanation is the way that expectations of easier policy from the Bank of England helped drive both “large exchange rate depreciations”. The 2007/08 one pre dates his tenure at the Bank of England but the post EU Leave vote one was on his watch. I still come across people who think he pumped £500 billion into the UK economy on the following morning rather than getting the ammunition locker ready. But he did cut interest-rates ( after promising to raise them) and pour money into the UK Gilt Market with £60 billion of Sledgehammer QE purchases.

So rather than something which just happened he and the Bank of England gave it a good shove and that is before we add in that he planned even more including a cut to a Bank Rate of 0.1% that November. That did not happen because it rapidly became apparent that the Bank of England had completely misread the UK economic situation. But by then the damage had been done to the UK Pound which was pushed lower than it would otherwise have done.

We get an implicit confirmation of that from this.

Since 2013, the MPC’s remit has explicitly recognised that there are circumstances in which bringing inflation
back to target too quickly could cause undesirable volatility in output and employment.

In other words in a world where inflation is lower than before  it is no longer an inflation targeter and instead mostly targets GDP. Actually we get a confession of this and a confirmation of a point I have made many times on here as we note this bit.

Indeed, on the basis of this past behaviour in the great moderation, the MPC would have raised interest rates by 2 to 3 percentage points between August 2013 and the end of 2014.

Due to the international environment with the Euro area heading for negative interest-rates that would have been to much, But we could have say moved from 0.5% to 1.5% as I have regularly argued and would have put ourselves on a better path. Oh and I did say that Governor Carney has no idea of the potential of the UK economy, so here that is in his own words.

What we – and others – learnt as the recovery progressed was that the UK economy had substantially more
spare capacity than previously thought.

UK Inflation

It is hard not to have a wry smile at UK inflation being bang on target after noting the above.

The Consumer Prices Index (CPI) 12-month rate was 2.0% in May 2019, down from 2.1% in April 2019.

Tucked away in the detail was something which should be no surprise if we note the state of play in the car industry.

there were also smaller downward contributions from the purchase of vehicles (second-hand and new cars).

The other factor was lower transport costs as air fares fell mostly due to the Easter timing effect and the cost of diesel in particular rose more slowly than last year. On the other side of the coin was something which has become very volatile and thus a problem for our statisticians.

Price movements for computer games can often be relatively large depending on the composition of bestseller charts.

Looking for future trend we see what looks like a relatively benign situation.

The headline rate of output inflation for goods leaving the factory gate was 1.8% on the year to May 2019, down from 2.1% in April 2019.

There had been worries about the input inflation rate which picked up last time around but the oil price seems to have come to the rescue for now at least.

Petroleum provided the largest downward contribution to the change in the annual rate of output inflation. The annual rate of input inflation fell 3.2 percentage points in May 2019, driven by a large downward contribution to the change in the rate from crude oil.

Welcome news from house prices

If we switch to this area we see that the slow down in the annual rate of growth continues.

Average house prices in the UK increased by 1.4% in the year to April 2019, down from 1.6% in March 2019 . Over the past three years, there has been a general slowdown in UK house price growth, driven mainly by a slowdown in the south and east of England.

The lowest annual growth was in London, where prices fell by 1.2% over the year to April 2019, up from a fall of 2.5% in March 2019.

I am pleased to see that as the best form of help for prospective buyers is for wage growth ( currently around 3%) to exceed house price growth. There is a lot of ground to be gained but at least we are making a start.

There is an irony here as I note that for once this will be similar to the number for rents that are being imputed as the inflation measure for owner-occupiers. Yes for newer readers you do have that right as the official CPIH inflation measure assumes that those who by definition do not pay rent rush out and act as if they do.

Private rental prices paid by tenants in the UK rose by 1.3% in the 12 months to May 2019, up from 1.2% in April 2019.

The problem for CPIH is that we have had an extraordinary house price boom without it picking anything up, so this is an anomaly and is unlikely to last.


There is a sort of irony in UK inflation being on target in spite of the fact that the Bank of England has mostly lost interest in it. The credit crunch era has seen other examples of this sort of thing which echoes when the Belgian economy did rather well when it had no government. We might well be better off if we sent the Monetary Policy Committee on a long holiday.

At the moment there have been quite a few welcome developments in this area. Because wage growth is positive compared to both CPI inflation and house prices after sustained periods of falls. Some caution is required as the RPI is still running at an annual rate of growth of 3% but we are in sunnier climes.There are troubles in other areas as the lower car prices highlight so we need to grab what we can.

Let me finish with a thank you to the Guardian for quoting me in their business live blog and for providing some humour.

Today’s drop in inflation means there’s no chance of the Bank of England raising interest rates on Thursday, say City economists.

Where have those people been in the credit crunch era?




12 thoughts on “The Bank of England reveals it is an inflation creator rather than targeter

  1. Shaun

    Most economies wants inflation the theory is inflation causes growth and deflation reduces growth, I hope I have got that right. But they don’t want hyper inflation history has taught us that is damaging. So the bank has set a target of 2% and as you say its bang on target!

    However RPI came in at 3% as against 2.9% forecast I prefer this measure. With RPI at 3% there are a lot of people out there will be feeling the pinch as highlighted by this BBC article on people in work and struggling to get by

    As for interest rates they are going nowhere fast that is because inflation isn’t going anywhere due to the preferred measure in your article.

    Well isn’t that handy as the BOE don’t want a house price collapse so they can continue to talk up a rate rise but know there wont be one.

    Inflation is falling all around the globe in the most important economies however and who will be the first to cut interest rates? Probably the US we should know soon.

    I wonder readers watched the debate last nigh on the prospective PM I like many of the UK public was left disillusioned with all of the candidates most apart from one making promises on taxation knowing full well it will be difficult to deliver in a global slowdown and more money needed for the NHS or social care.

    To be perfectly frank about all this I don’t think anyone in government at the moment got a clue and the BOE members are just as bad.

    • This made me laugh on Danny Blanchflower tweets:

      “In just over a month – after a vote by 160,000 Tory members who are 71% male, 97% white & 44% aged over 65 – one of these puffed-up, bumbling, clueless fools will become PM, & form the most right-wing govt in modern British history. ”

      God help us:
      – the government haven’t got a clue
      – the opposition haven’t got a clue
      – the BOE haven’t got a clue
      – the ONS uses data that is completely misleading
      – the UK got a hope in hell of dealing with a pension crisis and social care partly because they don’t want to tax the working class out of existence

      The UK just about fed up with crime going up, and being constantly fed misleading information from just about every public institution and I wouldn’t like to guess what would happen in a general election but feel it would be a total mess and not what is needed to improve growth in the UK.

      All I can say is make the best of what you have got readers are wasting their time if they think our modern day Moses will bring us to the promised land of milk and honey because it isn’t going to happen.

      The UK was the world leader in the Industrial revolution but the money has now been spent some of our best UK companies sold off to foreign buyers Qatar own a fair percentage of shares in Footsie companies including banks and lots of land as well:

    • Hi Peter

      I avoided the political debate on the BBC and watched England’s under 21s although ironically that didn’t go well either. As to inflation you have the theory right but there is less and less backing for the idea that low inflation heads to deflation in my opinion. Still it looks like the Fed has at least rejected one of the madcap ideas from the inflation nutters.

  2. Great article as always Shaun.

    With the ECB threatening to fire up the printing presses, do you think Carnage will follow? What better gift the leave the proles than a final trouncing of the pound and inflicting further inflation on the masses?

    People do not seem to understand the impact the boe and government have had on this country. In todays press:

    High housing costs being one of the main factors. Incredible that the government and boe have worked together to make housing unaffordable, and yet no-one challenges them (apart from this webpage).

    • Hi Anteos and thank you

      The Bank of England have already voted although we do not get told until 12 pm tomorrow. With Draghi’s speech and the assumption tonight that the US Federal Reserve will cut in July then Mark Carney’s Forward Guidance for interest-rate rises looks out of kilter.

      So we could see the unreliable boyfriend live up to his moniker one more time.

  3. Does anybody really listen to, believe or care what these liars and charlatans say any more? You have the Fed saying that rates were a long way from neutral at the end of last year and would be raising rates numerous times in 2019, following the predictable stockmarket tantrum that saw it fall 20% in a month they did a complete 180 and said they would be patient and followed that up with saying that policies that were previously used for crises could become part of its regular policy toolkit – translation: QE and zero/negative interest rates are here forever.

    Draghi in his post ECB meeting on June 6th said rates were expected to remain constant until the first half of 2020 before they would RAISE them with the bias on RAISING rather than cutting, However yesterday he came out and said :
    ““in the absence of improvement” of inflation, additional stimulus will be required, in form of further cuts in policy interest rates and additional bond purchases”, and how “in the coming weeks, the Governing Council will deliberate how our instruments can be adapted commensurate to the severity of the risk to price stability,” and that “all these options were raised and discussed at our last meeting.” (Translation:Rates are going lower and QE is being ramped up!!!!)

    Errr… except they weren’t discussed apparently, the other members were aware of vague mentions of the above but no serious debates and “only in passing”, nothing was agreed.

    And not forgetting our own Spinal Tap rockstar Carney, who after saying rates were going up in 2016 then proceeded to cut them following the BREXIT referendum.

    Forward guidance? What a joke. Above are three examples of them doing the complete opposite of what they offered as forward guidance which is considered so important by the market the “experts”, who say it is essential to the stability of the markets that the central banks message is telegraphed in advance so as to avoid any shocks or unnecessary volatility!!!

    Journalists and “economists” can pontificate about central bank policies until the cows come home, but anyone with an IQ bigger than their shoe size can see these clowns are trapped by their own policies into perpetuating the bubbles they have created and cannot now reverse these policies for fear of the catastrophic collapse they will cause.

    • Hi Kevin

      Cheers for the link as I like a bit of 10cc. There was a good documentary on them on BBC 4 about a year ago.

      According to Mark Carney yesterday Forward Guidance is a triumph.

      “The biggest innovation in communication has been the introduction of forward guidance as a tool to influence short-term interest rates once policy rates hit the effective lower bound. The objective has been the same for both the ECB and the Bank of England – to clarify our reaction function in a highly uncertain world.
      In a perfect world, guidance would be redundant.

      People would know how the Committee intends to set rates over the future and how those intentions would adjust to economic developments in all eventualities – the so-called reaction function. But the world is complex and people (outside this audience) don’t have
      endless time to devote to understanding monetary policy. In practice, therefore, guidance can be useful in providing people with information about how the Committee sets policy and, over time, in improving the understanding of how monetary policy will adjust to news.”

      Meanwhile back in the real world the unreliable boyfriend lived up to the description by encouraging people to take out fixed-rate borrowing and then cutting interest-rates. We may be approaching take-two for that.

  4. Hello Shaun,

    re: “annual rate of growth of 3% but we are in sunnier climes”

    I disagree as you may well guess 😉

    RPI is closest thing we have, it must be , it’s used for taxation ( not benefits !)

    or RPIX

    we assume that the difference between RPI and CPI inflation is around 1.4 percentage points in the long run. ;- ref Ruth Miller OBR 2011

    meaning over ten years you’d see a difference of approx 15% ( check my cal please 😉 )

    it’s a swindle !

    perhaps we need not take this any more



    • Hi Forbin

      I am a RPI fan too, but even with it real wages have stopped falling. As to the gap between the numbers in the long-run I would expect it to be more like half that at say 0.7% or so. No more than 1% anyway.

  5. Great blog as usual, Shaun.
    The CPI inflation rate is down from 2.1% in April to 2.0% in May. The inflation rate for the RPI ex mortgage interest and council tax is also down, but from 2.4% to 2.3%. So based on this arguably better target inflation indicator for the Bank of England, inflation in the economy is still above its 2.0%inflation target. Dwelling insurance, excluded from both the CPI and CPIH, saw its annual rate of price change go from 5.9% in April to 6.3% in May.

    • Hi Andrew and thank you

      You had me going for a moment as I was about to reply the old target was 2.5% but then realised that you had missed out a J. So yes going forwards with an RPIJ style inflation measure would be an improvement as it would correct part of the loosening of the inflation target when it was converted to CPI.

      • Thank you for your reply. You are right. I apologize. I meant to write “RPI ex ex mortgage interest and council tax, adjusted for the formula effect.” I thought the way to go was to add a monthly OOH component based on net acquisitions to the CPI, and for a while even Mervyn King seemed to be willing to go that way, but after so many years of waiting for it, it still hasn’t come and it may come with pretty unpleasant features. So maybe the Bank of England really should go back to an RPI-type inflation indicator and ONS could work on reforming it to better serve the BOE’s needs. I also should have said that dwelling insurance is not explicitly part of CPIH. Of course, conceptually the bulk of it should be reflected in the imputed rents. I’m not sure how seriously we should take this.

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