MNI INTERVIEW: BOE Needs Clearer Inflation Picture Before Cuts

The Bank of England should be cautious before making further rate cuts, as it is still not clear that inflation will settle comfortably around the 2% target over the medium term, a former Monetary Policy Committee member told MNI.

"One thing that strikes me about the inflation numbers is that they've been very variable, especially if you look at the last four inflation numbers, 3.6, 3.2, 3.4, 3.0%. So what does that tell you about the direction of travel? First of all, it doesn't tell you that it's heading towards 2% necessarily," said Andrew Sentence, who served on the rate setting committee between 2005 and 2011.

"This is something that people haven't picked up on properly, given that the MPC is meant to be trying to plot the course and direct inflation for the medium term," he added, noting that they "shouldn't be adjusting policy on the basis of one month's figures."

The BOE left Bank Rate on hold at 3.75% earlier in February but said further rate cuts were likely, with inflation forecast to fall close to 2.0% in April.

Sentance said the BOE should focus on other inflation measures than the headline gauge.

"The question is, what are the underlying forces driving inflation? I’m not sure that that picture there has changed very much," he said.

GOVERNMENT POLICY

Measures in the government’s November budget to cut consumer energy costs should help push inflation a little lower in the near term, "even though the Chancellor probably can’t afford it given the poor state of the public finances," Sentance said.

"Whether the MPC are going to do enough to have a sustained impact on the consumer price index -- I doubt it. It's not convincing to me. I think they should actually calculate a version of the CPI which excludes all this government fiscal policy action designed to massage down inflation," he said.

Short of that, Sentance thinks the MPC should watch the CPI ex-energy measure, which excludes electricity and gas bills, and then petrol and diesel prices.

 "That is currently at 3.2% slightly higher than the 3.1% which is the core CPI that most people look at,” he said.

While the MPC is meant to look through short-term fluctuations, "whether they will do or not, I don't know," Sentence said. 

LABOUR MARKET

The recent deterioration in the jobs market "seems to be abating to some extent," but policymakers must consider the extent to which the deterioration in unemployment and employment numbers is due to structural factors, he said.

"Andrew Bailey keeps saying, ‘we keep everything under review and we will take action, if necessary, to bring inflation back to target,’" Sentance noted, but added that "nothing in their actual actions recently to back this up".

"They have been cutting interest rates at the time when they ought to be either pausing or possibly even increasing interest rates. It doesn't make sense.” (See MNI INTERVIEW: Labour Market Weakness May Tame UK Inflation )

ANTICIPATION

The MPC has been "cutting interest rates in anticipation that inflation would come down .... assuming that inflation would come down, and they've been cutting interest rates on that basis," Sentance said.

"What that would imply is that most of the reduction in inflation, even as far as going down to 2% is mainly factored into interest rates already," he said. “When people say there's one more interest rate cut to come this year, that's probably a realistic assessment. But then there's not much more to go after the Bank has more or less said that around three-and-a-half percent is their sort of medium term estimate of where interest rates should be.”

Sentance would have tried to keep interest rates higher while inflation is above target, looking to trim Bank Rate when inflation is around 2%, an approach which he said would allow some leeway if inflation surprises.

"If inflation is a bit sticky above that level, then they're going to be stuck," he said.