Select Committee on Treasury Minutes of Evidence


  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

Chart 1-3

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