The exercise only considers the direct effects of tightening, and abstracts from any indirect effects via, for example, the exchange rate or incomplete pass-through. Source: Bank of England, ONS, Bloomberg Finance L.P. and Bank calculations. Summary and conclusion One often hears that real incomes are lower “because of” inflation. In some ways the opposite is closer to the truth: (domestic) inflation is higher because of (external) hits to real incomes. The economy has been hit by severe real shocks. The pandemic raised the global demand for goods and reduced their supply; Russia has cut back severely its supply of gas to Europe. These have had dramatic effects on relative prices (Chart 12 shows the dispersion of inflation rates across the components of the CPI). In particular, import prices have risen significantly compared with the price of UK output. This has unavoidably depressed real incomes: the volume of output may have just about recovered to pre-Covid levels but its consumption value has not. Bank of England  Page 20  Chart 12: There have been big shifts in relative prices within the CPI Standard deviation of annual inflation rates across the 85 CPI items 20 18 16 14 12 10 8 6 4 2 0  20 18 16 14 12 10 8 6 4 2 0  96  98  00  02  04  06  08  10  12  14  16  18  20  22  Source: ONS and Bank calculations.
Because of the infamous “long and variable” lags between changes in interest rates and their impact on inflation, the MPC does not yet have much of a track record in terms of inflation outturns. But since the target given to the MPC is for inflation, let me start there. Between June 1997 and March 1999 (the latest month for which inflation has been published) RPIX inflation averaged 2.7%. During that period, inflation ranged from a low of 2.4% to a high of 3.2%. Over the past nine months it has remained within 0.2 percentage points of the target, a remarkable degree of stability. It is most unlikely that inflation can remain, month-by-month, as close to the target as that. Unexpected movements in the exchange rate, oil or other commodity prices, indirect tax rates or a multitude of other influences could all lead to divergences of inflation from target. Because of the lags I mentioned earlier, it would take the MPC some time to bring inflation back to the target level. What matters, however, is not relatively small month-to-month movements in the inflation rate, but the expectation that inflation will average 22% over a number of years. As part of the arrangements for accountability, the Governor, on behalf of the MPC, is required to write an open letter to the Chancellor whenever inflation deviates by more than a percentage point from the target.