And the Obama administration is seeking to inject a further fiscal stimulus, incorporating not only the widely expected extension of the Bush administration tax cuts, but also a temporary cut in payroll taxes. The extension of the Federal Reserve’s large-scale asset purchase programme has proved controversial, with some US critics asserting that it is inflationary and policymakers in some of the emerging  2  BIS Review 169/2010  economies claiming that it is both an attempt to engineer a beggar-my-neighbour devaluation and that it will boost capital inflows and foster asset-price bubbles. These criticisms seem to me mostly off the mark. Central banks undertake asset purchases financed by the issuance of central bank money in order to boost nominal spending. They do that by depressing a range of longer-term real yields and raising asset prices. The earlier phases of quantitative easing both here and in the United States indeed appear to have lowered longer-term nominal and real yields below where they would otherwise have been. 2 This time around, the transmission channel has been rather different, as after falling on the anticipation of further asset purchases, longer-term US yields rose. But the policy should only prove inflationary in the medium to long run if it results in excessive nominal spending growth, which hardly appears likely at the current juncture. Only if the Federal Reserve fails to tighten policy promptly as the recovery takes hold is excessive inflation likely to be a problem. The criticisms from outside seem to me almost as misplaced.
But given the very high degree of uncertainty, there is little that the MPC can do to deal with this risk ahead of crystallisation. While UK output growth has come in much in line with our expectations, the same cannot be said of our primary objective, inflation. Back in August of last year, our central projection was for CPI inflation to be around 1.5% now. But inflation has been markedly stronger than that – 3.2% on the latest reading. Why has inflation been so much higher, especially given that our expectations for growth have largely been fulfilled? There are three factors that account for this. 3 First, energy and non-oil commodity prices are substantially higher than in the summer of 2009. By convention, we base our forecasts for these variables on futures prices, which were relatively flat at that time. The buoyancy of commodity prices since then reflects the rebound in global activity, and especially the strength in the emerging economies. In addition, temporary supply factors have boosted the prices of some agricultural commodities. At present there appears to be a margin of spare capacity in the oil market, so that may permit global growth to remain strong without putting further upward pressure on energy prices immediately. But a low elasticity of supply of other commodities means that their prices, relative to those of finished goods and services, may continue to drift upwards. That would constitute an additional headwind for the United Kingdom.