This difference in inflation outturns gives some sense of how monetary policy settings are believed to matter. And the close to one percentage point gap is significant, certainly when compared with the inflation target of 2%. But this difference between Bank Rate scenarios is dwarfed by the overall fall in headline inflation of almost nine percentage points from its peak. That fall is testament to the size of the external shock to which UK inflation has been subject. It gives some measure of the challenge the MPC has faced in the past year in addressing the surge of inflation – a challenge of unprecedented magnitude in the inflation targeting era. There is a long history of MPC forecasts being interpreted as offering an implicit policy view on the interest rate paths upon which they are conditioned. And, prima facie, the constant rate scenario contained in the MPC’s May report appears to justify the guidance that ‘some degree of further tightening in monetary policy may still be appropriate in the coming months’: maintaining Bank Rate at 1% would fail to achieve the 2% inflation target within the forecast period. In my short time as a member of the MPC, I have made it a rule not to comment on the appropriateness or otherwise of market-implied or variant interest rate paths. And I am not going to change that practice today.
If we were to see commodity prices rise further, would this lead to stronger second round effects in domestic wage and price setting behaviour? Or would the real income squeeze implied by higher energy prices lead some of those that left the labour force during the pandemic to seek jobs, easing cost pressures stemming from the tightness in the labour market? The scenarios published by the MPC thus far reveal the impact of changing one of the conditioning assumptions for its baseline forecast, while holding the other assumptions unchanged. Such exercises can provide insight into the marginal impact of changes in the assumptions on the inflation outlook. But they don’t reveal the overall impact that incorporates the joint interaction among the conditioning assumptions. In interpreting the implications of the MPC’s published forecast and scenarios for the monetary policy outlook, this limitation of the published scenarios needs to be kept in mind. The conjuncture To sum up, the MPC’s current forecast embodies a tension between two elements. On the one hand, headline inflation is clearly too high, the UK labour market is tight, wages are growing at stronger rates than would normally be deemed consistent with the inflation target, and business confidence is resilient, in part in anticipation of being able to re-establish profit margins. In short, inflationary momentum in the UK is currently strong.