MEMORANDUM BY MR ROGER BOOTLE, SPECIALIST
ADVISER TO COMMITTEE
1. The latest Inflation Report envisages
a moderation in output growth, followed by a recovery, with an
accompanying weakness of inflation in the near term, followed
by the now familiar pick-up to the 2.5 per cent target at the
two year forecast horizon. I broadly concur with the view of the
output profile, but the issues again concern the prospects governing
the inflation rate further out, and the apparently skewed nature
of the risks surrounding the forecasts.
2. The fact that the inflation rate has
undershot the target consistently for 22 months should make one
rather sceptical about the Bank's now ritualistic forecast of
inflation picking up within two years. The past good inflation
performance has been achieved against the backdrop of adverse
oil price developments and heavy increases in petrol duties. Indeed,
as Chart 1 shows, if petrol prices are stripped out of the RPI,
then RPIX inflation would already have dipped below the 1.5 per
cent lower bound which triggers a letter from the Governor to
the Chancellor. Moreover, during the last year, the economy has
been growing strongly, with private consumption particularly strong.
The one factor pointing in the opposite direction has been that
until recently the exchange rate has failed to fall in the way
that the Bank had assumed (as Chart 2 shows). But sterling
is now below the level projected by the Bank over the last year.
3. We expect RPIX inflation to fall
below the 1.5 per cent lower bound sometime this summer with June
(figures released in July) being the most likely month. The
Governor appears to take a relaxed view of the significance of
having to write a letter. It is certainly true that the MPC has
been uncannily lucky in not having had to write a letter so far,
but if one has to be written this summer it will be rather more
significant than many possible letters which might have needed
to be written. For this would not be the dipping below target
as a result of some unexpected shock, such as a sharp fall in
oil prices or seasonal food prices, but rather the culmination
of a long period of systematically over-estimating inflationary
pressures. In these circumstances, the fact that inflation had
fallen below 1.5 per cent would surely demand a serious response
from the Governor.
4. There appears to have been a sharp divergence
of views on the MPC which again leaves the status of the so-called
"central forecast" somewhat unclear. The February Report
says that some members prefer alternative assumptions about supply
side developments and about the extent and consequences of the
US slowdown which, together, could reduce inflation at the two
year horizon by up to 1/2 per cent. But no one is quoted as seeing
risks in the other direction. One is left with the suspicion
that the "central forecast" is being driven by hard-line
members of the Committee, and that it does not fairly reflect
the balance of views on the Committee as a whole.
5. It is again very striking that other
measures of inflation give even lower figures than the targeted
measure, RPIX. It is by now well-known that the common European
harmonised measure, HICP, consistently produces a lower inflation
figure than RPIX. (The January figure was 0.9 per cent compared
with 1.8 per cent for RPIX.) But other, less well-known, measures
also reveal striking differences. The annual increase in the Consumer
Expenditure Deflator (which covers a broader sweep of household
spending than retail sales) in Q3 of last year was only 0.6 per
cent, the lowest for 40 years. And the GDP Deflator, covering
price movements across the whole economy, not just consumer spending,
stood at 1.6 per cent in Q3, compared with RPIX of 2.1 per cent.
15 February 2001
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