But even abstracting from the snow, activity seems to be have been broadly flat. How much should we read into that? One possibility is that the figure is simply erratic or will be revised away in due course. But other indicators – particularly some measures of consumer and business confidence – also weakened during the second half of the year,  3  While some outside commentators regarded that projection as being on the optimistic side, it would still have left output below its pre-crisis level until 2011 Q4 and broadly in-line with the average experience after banking crises recorded by the IMF (Chart 1). 2  BIS central bankers’ speeches  suggesting that something more substantial may have occurred. It could just be a short-lived soft patch – after all, recoveries are rarely smooth. Indeed, that is the judgement incorporated in the projections we published a couple of weeks ago (Chart 2). But it could instead be the harbinger of a more durable slowing – only time will tell. Let me now turn to the sources of the recent elevated inflation and the chances of inflation remaining above our 2% target into the medium term and beyond. A year ago, in our February 2010 Report, our central expectation was that inflation would be around 1% in the first quarter of this year. Yet in January, CPI inflation reached 4% and is likely to move higher in the coming months, in part reflecting the recent surge in oil prices.
Input-output data suggests that goods are between two and three times more import intensive than services. The implied contributions of import prices to inflation under these two assumptions are shown in Chart 8, with import prices contributing between 2 and 3 percentage points to inflation in late 2009/early 2010. Back in 2009, our central view, embodied in successive Inflation Report projections, was for inflation to oscillate around the 2% target over the next couple of years, with the upward pressure from sterling’s depreciation very broadly offset by the downward pressure from spare capacity and additional volatility induced by the restoration of the crisis-driven cut in VAT. That view was predicated on a considerable body of research, for this and other countries, which suggested that the pass-through of exchange rate movements into consumer prices had fallen in the past two decades 6 . That research pointed to better anchoring of inflation expectations as one possible cause, coupled with an increased tendency to “price to market”, meaning that more of exchange rate movements were absorbed in either profit margins or in other costs, rather than being passed on into prices. In the event, the pass-through seems to have been rather larger, and closer to that seen prior to the Great Moderation. In part, that may reflect the recognition by market participants and businesses that a substantial decline in the real value of sterling was necessary to re balance the economy and the fall was consequently likely to be permanent.