MNI INTERVIEW: Inflation Expectations Resisted BOE Hikes-Weale

Firms' price increase expectations during the post-COVID inflationary period were not significantly affected by UK monetary policy shocks which saw Bank Rate climb from 0.1% to 5.25%, according to new research by ex-Monetary Policy Committee member Martin Weale, with the findings suggesting a de-anchoring from target.

These findings "might suggest a greater restrictiveness of policy, possibly depending on how quickly the Bank wanted to bring inflation down," Weale said in an interview with MNI.

“The sort of story that I could tell, which I think is quite plausible, is that in the period before the [high] inflation, when there was less going on, firms’ expectations were responsive but actually firms weren't terribly bothered either.”

Weale said that the inflationary episode still appears to be playing out, even as the Bank weighs further policy easing, with current MPC members divided over how much importance to attach to inflation expectations.

Asked why firms' expectations had not responded to unexpected shifts in monetary policy, Weale replied: "perhaps they tended to respond rather more to the inflation that had actually happened than to the signals that the Bank was giving. And if we look at the time it's taken to bring wage inflation down after the inflationary episode, then I think that's largely consistent with that view."

OTHER CHANNELS

Central bankers regularly cite the risk of inflation expectations decoupling from the target during high inflation episodes, but Weale’s paper suggests that expectations simply stop reacting to policy shocks.

"I suspect that [inflation expectations] did get de-anchored, and at least a plausible explanation is that it's because they were de-anchored, they ... were less sensitive to shocks from the Bank of England in the higher inflation period than in the low inflation period,” Weale, an MPC member from 2010 to 2016, said. 

“In other words, people just paid less attention to what the Bank of England was saying."

Although greater restrictiveness could have helped lower inflation by constraining firms' expectations, Weale stressed that monetary policy can impact inflation through other channels.

"We don't exhaust the ways in which inflation could actually be controlled in this paper. So, if monetary policy is tightened, then that presumably has an effect in supporting the exchange rate, and that brings inflation down ... that sort of mechanism isn't examined in this paper. And even if it does not affect firms’ expectations, monetary tightening may still influence demand and, through that route, prices."

INFLATION GENIE

Using data from the CBI Industrial Trends survey, which has the longest-run expectations data, the paper, co-authored with ex-BOE economist Tomasz Wieladek, is based on data up until Q3 2024 but Weale believes the high inflation episode is not yet completely over.

"I would say that the high inflation is still playing out. Of course, that doesn't rule out the possibility that as the numbers have come down, which they have, so the response to shocks has changed again. But as I say, you can't subdivide it up into lots of short periods and expect to get sense out,” he said.

"The Bank of England's view is that ... over the next eighteen months, inflation is going to fall back to the target, or close to the target, but I think we are still seeing the unwinding of especially the surge in wage growth that we had as a result of inflationary pressures a few years ago."

"If you're a policy maker doing it now, you would like to see the wage data actually materialize lower, rather than just assuming they're going to keep trending down ... that is coming down now."