How will the Bank of England deal with the cost of living crisis?

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by Shaun Richards

On Friday we were treated to the first formal speech from a Bank of England policymaker for a while. It was one of the new external members Catherine L Mann who is an example of a disappointing but consistent move by the Bank of England which she highlighted in her first sentence.

As an international economist, I have always studied domestic economic conditions through the lens of
global influences.

She has no particular expertise in the UK economy and in fact is an American who has spent her life in the international bodies which have consistently failed us. We have plenty of British female economists who get overlooked time and time again. Just in case you thought it was because of Catherine’s abilities well the important issue for 2022 is inflation and the consequent cost of living crisis. She told us there wasn’t going to b any in the UK as recently as July last year. This is from her application process.

Only in the US is CPI inflation expected to exceed the 2% objective for some years. Inflation in other AEs
does not breach 2% at least as measured on an annual basis. For EM as well, after the 2021 boost in inflation, their average inflation also is expected to moderate substantially. ( AEs =Advanced Economies )

Could she have been more wrong? Well yes as she went on to assure us that central banks had the matter in hand.

While the conclusion might be that monetary authorities have inflation well in hand, the other conclusion is that policy moderates too soon

Even worse she looks to have been in favour of more expansionary policy into the present inflation surge.

What about now?

Her view on inflation has done a complete U-Turn

Global factors have been at the forefront
of the inflation surge in the UK, and their effects will persist into early 2022. However, expectations for
wages and prices for this year, if realized, could keep UK inflation strong for longer, which might then
generate a reinforcing cost-price dynamic.

Perhaps her error last July is still on her mind.

In the last half of 2021, UK CPI inflation surged, more than doubling from 2% in July to 5.4% in December.

Now she fears that 2022 will be even worse in inflation terms than 2021.

Residual strength in both wages and prices likely will continue for a time into 2022 as the domestic and global mismatch of supply and demand slowly resolve, as firms try to recover margins eroded in 2021, and as labour markets stay tight. Indeed, firms in the latest DMP panel (from December) expect to raise their prices by 5% in 2022 – a bit more than the 4% in 2021.

Rather curiously she seems to have retained quite a bit of faith in the wages data that I reported to the Office for Statistics Regulation in February last year.

Previously, average earnings had rebounded strongly from their trough in 2020 leading to headline wage
inflation rates as high as 9% in the summer. While some of these increases are due to base and compositional effects, demand and supply imbalances both in goods and labour markets built very quickly over the second half of the year.

You might reasonably think she would have her doubts about the wages numbers when she is told a completely different story by those paying them. But that detail seems to escape our Catherine.

Meanwhile, firms expect continued upward pressure on pay growth in 2022 on the top of the 2-3.5% increases of 2021.

So was it 2%-3.5% or rising to 9%? Most would be troubled by a gap wide enough to drive the QE2 through.

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Anyway she now thinks that inflation could continue on its present high trajectory into next year.

These expectations for prices and wages, if realized, are ingredients for headline inflationary pressures that could
stay strong for longer, well into 2023.

Her attempts to explain away the inflation by trying to blame particular areas have failed as she ends up having to confess that most areas are rising.

Starting in the second half of 2021, however, rates in the lowest-volatility bucket have left their range of the
last decade and now look more in line with the period of 2011 and before. This tells me that high inflation is
no longer limited to components that are usually quite volatile, but has seeped into those that typically are
rather stable

Oh and she probably does not realise it but she has given a critique of the use of rents as a proxy for housing inflation.

Some examples are pharmaceutical products and hairdressing, but also housing rents, and restaurants and canteens – these latter two each account for over 8% in the CPI basket.

After all house prices are not low volatility are they?

Also you may miss in the explanation below the fact that the UK is expected to have the highest GDP growth in 2022 of the countries in Catherine’s chart.

But, prospects for 2022 GDP growth in the UK, coming from Consensus Economics for example, have been systematically downgraded over the course of
2021 to the January 2022 survey. With this downgrade, the UK economy is a clear outlier among advanced economies.

If we are the outlier I wonder how the others got downgraded too?

As well, prospects for global GDP growth have been dialled back for 2022 by the international institutions

It is all very curious as again we are told we are doing badly when we are the best performer on her chart.

 in any case, UK trade has underperformed the pace of recovery in global trade perhaps augmenting domestic headwinds from global demand.

Comment

So what will Catherine do in terms of policy? Well she seems to think the December 0.15% interest-rate rise was a big deal.

The small Bank Rate rise that I voted for in
December was to act on the commitment to the 2% target so as to influence the 2022 strategic decisions that workers, businesses, and asset holders are now making. Changing expectations is the first defence against a reinforcing wage-price dynamic.

Does she really think that a 0.15% interest-rate rise will influence “strategic decisions”?! After all economic history has seen much larger rises struggle to have much of an impact. She seems to be arguing it is simultaneously small and significant. The last sentence is very revealing as it highlights what she actually believes.

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In fact we see that she prefers expectations over reality as this issue pops up regularly in her speech. The quote below is from her first paragraph.

To return inflation to target, the Monetary Policy Committee’s first line of defence is to dampen expectations of future price increases. Achieving an inflection in these
expectations along with tailwinds from global factors could mean that a shallower path of future rate rises is
needed to bring inflation back to target.

How does it “dampen expectations” other than by increasing interest-rates? We seem to be singing along with Earth Wind and Fire here.

Every man has a place, in his heart there’s a space
And the world can’t erase his fantasies
Take a ride in the sky, on our ship, Fantasii
All your dreams will come true, right away.

How many people even knew she gave a speech? Not that many. You may note that she seems to think that it could lead to fewer interest-rate rises. But how? Perhaps she has been in the bodies filled with the supposedly “great and the good” for so long she actually believes all the hype.

She is back at the same game later in the speech.

Monetary policy has a role to play in managing expectations as well as ensuring that the economic and financial conditions facing firms and workers are consistent with the 2% target.

Let me put it bluntly. As her expectations about the inflation trends were completely wrong why should anyone take her seriously? Let alone act in accordance with her judgements.

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