Strong pound might not have lasting effect on inflation: BoE’s Forbes

12 Sep, 2015 12:48 pm

CARDIFF – The Bank of England might have to raise interest rates sooner than its models suggest if the pound’s surge over the past two years has less of an impact on inflation than currently thought, a top official at the central bank said.

Kristin Forbes, a member of the Bank’s rate-setting committee, said some of the basic assumptions about the influence of the exchange rate on inflation did not do a good job at explaining what was going on in Britain.

More emphasis was needed on the underlying reasons for moves in a currency which could have different outcomes on inflation.

“Perhaps most important for monetary policy today, this approach also suggests that sterling’s recent appreciation could create less drag on import prices and inflation than we might have expected if the levels of pass-through seen after the crisis persisted,” Forbes said.

“If this plays out, monetary policy would need to be tightened sooner than based on older models,” said Forbes.

Forbes has so far voted to keep rates on hold since she joined the Bank last year, but economists say may be the next policymaker to join Ian McCafferty in proposing a hike in interest rates.

The BoE cut interest rates to a record low of 0.5 percent in 2009 and has kept them there ever since, despite a strong recovery in the economy over the past two years.

BoE Governor Mark Carney has said the time for a rate hike is approaching and a decision is likely to become clearer around the turn of the year.

The role of sterling, which has appreciated by 17 percent against a range of other currencies since the spring of 2013, is central to the BoE’s thinking. Forbes said the rise in the currency was mentioned 11 times in the minutes of the Monetary Policy Committee’s August policy meeting.

When the pound plunged during the financial crisis, the Bank failed to predict how big an impact it was going to have on inflation, which surpassed 5 percent in 2011. But Forbes said the role of the currency appeared smaller this time.

In her speech, Forbes said new research showed that, contrary to most thinking, components of Britain’s consumer price index that are import-heavy and sectors of the economy that face a lot of international competition did not appear to be more sensitive to exchange rates.

Furthermore, the pass-through of currency movements did not seem to be constant over time, she said.

“This limited understanding of how exchange rate movements affect inflation is – to be candid – quite frustrating for those of us tasked to set monetary policy.”

Sterling’s rise was driven partly by domestic demand, allowing companies to maintain sales without lowering prices as much in response to increased competition from abroad.

Furthermore, weak productivity growth means companies were probably finding it harder to reduce prices, Forbes said.

“This could be a key reason why there appears to be less pass-through from recent exchange rate movements today than occurred during the 2007/8 depreciation,” she said. -Reuters

Must Watch

Oops, something went wrong.