BoE Shows Concerns Over Low Inflation

Inflation rate is more likely than not to fall below zero, according to latest Inflation Report released by the Bank of England. Policymakers also said they are ready to take whatever action is needed to ensure inflation comes back to target, including cutting rates.

Excerpts from the Inflation Report, February 2015:

CPI inflation was 0.5% in December 2014, well below the 2% target. The main reason for this was the steep fall in wholesale energy prices during the second half of last year. Inflation is likely to fall further in the near term, and could temporarily turn negative, as falls in energy prices continue to be passed through. Inflation is likely to rebound around the turn of the year as these effects drop out of the annual rate.

The fall in oil prices, together with monetary policy measures taken abroad, should support global demand. Lower energy prices will also boost UK real income growth. That, along with a lower expected path for Bank Rate than in November, should help to sustain the recent robust expansion in UK domestic demand. As slack is absorbed, inflation is projected to rise back to levels consistent with the inflation target. The Committee judges that it is currently appropriate to set policy so that it is likely that inflation will return to the 2% target within two years. Under the assumption that Bank Rate rises gradually over the forecast period, that is judged likely to be achieved.

Inflation is below the target while unemployment is above its long-run sustainable rate. There is therefore no immediate trade-off between returning inflation to the target and supporting economic activity. In fact, to return inflation to the target it is necessary to eliminate the remaining degree of economic slack. It is therefore appropriate to aim to return inflation to the target as quickly as possible after the effects of energy and food price movements have abated.

At its meeting on 5 February, the MPC noted that conditional on interest rates following the path currently implied by market yields, it was likely that slack in the economy would be absorbed and inflation would return to the 2% target within two years.

As set out in this Report, there are risks to the inflation outlook in both directions. Were downside risks to materialise, market expectations of the future path of interest rates could adjust to reflect an even more gradual and limited path for Bank Rate increases than is currently priced. The Committee could also decide to expand the Asset Purchase Facility or to cut Bank Rate further towards zero from its current level of 0.5%. The scope for prospective downward adjustments in Bank Rate reflects, in part, the fact that the United Kingdom’s banking sector is operating with substantially more capital now than it did in the immediate aftermath of the crisis. Reductions in Bank Rate are therefore less likely to have undesirable effects on the supply of credit to the UK economy than previously judged by the MPC. Were upside risks to materialise, it would be appropriate for Bank Rate to increase more quickly than embodied in current market yields but the likelihood is that those increases would still be more gradual and limited than in previous tightening cycles.

The MPC stands ready to take whatever action is needed, as events unfold, to ensure inflation remains likely to return to target in a timely fashion. Under the central case, the MPC judges it more likely than not that Bank Rate will increase over the forecast period.

BoE | Joana Taborda |
2/12/2015 11:18:06 AM