With the benefit of hindsight, at least in our own analysis at the Bank, the complexity of global value chains was not well enough understood and, as a result, the duration and intensity of disruption was probably underestimated. Fortunately, supply disruptions appear to have eased in recent months and there have been some, albeit still tentative, signs of a normalisation in the patterns of US consumer demand. Global goods price inflation has weakened somewhat, and that has passed through into UK core goods inflation. Against that, the end of the zero-Covid policy in China may have again increased the uncertainty surrounding supply bottlenecks. On the one hand, less strict restrictions in China should ease supply constraints if lockdowns are fewer in number. But, on the other hand, the current surge in infection rates may create its own disruption to production and distribution. Ultimately what matters for an inflation targeting central bank like the Bank of England is the implications of these developments for world export prices and thus imported inflation. This is something we will have to  Page 6  continue to monitor closely. Tight labour markets In both the UK and the US, the labour market has remained tight. The UK unemployment rate recently reached its lowest level since the mid-1970s. Recruitment difficulties in a tight labour market have supported stronger underlying wage growth. The relative contributions of demand and supply to labour market tightness are a topic of intense debate.
[9] On this basis, the inflationary impact of a deterioration in the terms of trade could be seen as selfcorrecting, since it will generate weaker domestic demand that eases the inflationary dynamics that higher energy prices trigger. Since an adverse terms of trade shock can create self-sustaining inflationary dynamics in the economy, it can be understood as raising at least temporarily the level of unemployment that is required for inflation to be at target – the so-called NAIRU. But how much the NAIRU will rise (and for how long) depends on how actively and persistently domestic firms and workers seek to sustain their own real incomes in the face of that shock. In coming to a view on how much monetary policy needs to respond to these inflationary pressures, the MPC will need to assess how much the NAIRU has risen and how much of a rise in unemployment will anyway follow from the weakening of demand owing to squeezed household incomes. Recent MPC communication In December, the majority of the MPC stated that, should the data largely follow the outturns foreseen in our November forecast, further increases in Bank Rate may be required for a sustainable return of inflation to target. Moreover, the Committee as a whole repeated that, if the outlook suggests more persistent inflationary pressures, it will respond forcefully, as necessary. This communication rightly places the persistence of inflation at centre-stage.