MNI INTERVIEW:UK Inflation Peaks Year End, Stays High-Sentance

UK inflation is set to rise to 4% by year end before receding to 3% by the end of 2027, leaving it well above target for at least the next two years, a former member of the Bank of England’s Monetary Policy Committee told MNI.

"I see inflation running at about 3% in the next release, which comes out next week, perhaps 3.1% and then hovering round about the 3% level for a few prints," Andrew Sentance said on Thursday.

Sentance said he had updated his short-term forecasts to reflect actions the government has taken on energy prices which will ease the inflation figures down. 

"In the short term that tends to mask the rise in inflation," he said. But, "on the presumption that petrol prices remain relatively high and the higher energy costs feed through into gas and energy bills, then I see inflation going up to about 4% in the winter, and then coming back down again to around about 3% over the course of 2027 -- none of which is consistent with the 2% inflation target."

HIGHER CORE INFLATION

One of the main inputs into above-target headline inflation is higher energy prices, though Sentance argues that a higher underlying rate of inflation is also feeding through -- and that the underlying rate is higher than the 2% he believes is assumed by many City analysts.

Wage demands and nominal domestic demand all point to core inflation "somewhere around 1% above the perceived 2%. So there's a core inflation rate, effectively around 3% rather than 2%," he said. (See MNI INTERVIEW: UK Jobless Drive Productivity Rise - Saunders)

There is also a risk that food inflation could pick up again, he said, noting "quite a few warnings about food inflation from the retail sector and from the farmers. But people sort of sweep that under the carpet."

BANK REACTION

As to the Bank's reaction to the resurgence in inflation, Sentance continues to argue that tightening is needed.

"Interest rates were cut from 5.25% to 3.75% in anticipation that inflation would come back quite easily to target, so, as inflation is not coming back quite easily to target, you really have to say ‘is 3.75% the right figure?’"

"I'm not saying Bank Rate has to be back up to 5%, but somewhere between 4 and 4.5% is where you should be moving interest rates to while you're trying to exert some downward pressure on inflation," he added. (See MNI INTERVIEW: BOE Needs To Hike In July - NIESR's Millard)

The quicker inflation slows the better, because "it means that the second-round effects of the surge in oil prices are much less likely to be to be felt," he said.

According to Sentance, any communication of intent through policy action "seems to be lost on the current MPC, apart from a few notable exceptions."

"One of the good rules about monetary policy is captured by an 80s pop song by Fun Boy Three and Bananarama. 'It's not what you do, it's the way that you do it, and that's what gets results.'”

"So the way in which you manage interest rates is just as important as the actual moves that you make, and one of the problems that the MPC have currently is they're too divided to present a clear message.”