Following intense scrutiny of the 4.0% CPI inflation number, all eyes were on the Bank of England press conference yesterday, especially following assertions in the Financial Times and other media that Governor Mervyn King had laid the ground for future rate increases in his recent letter to Chancellor George Osbourne. However, Mervyn King roundly contradicted this view, indicating that he had not intended to lead the market into believing interest rate increases were likely. Rather, King said that “some people are running ahead of themselves”.
It is hard to see then why some commentators have interpreted the report as indicating that rate rises are now more likely. The report itself goes to some length to explain the temporary factors pushing up CPI inflation. For the first time, the MPC published a chart illustrating its view of the underlying inflation rate, excluding the temporary impact of changes in value added tax, energy and import prices. The report indicates that underlying inflation is probably below 1.5%. As Governor Mervyn King reiterated at length in yesterday’s press conference, the MPC is concerned about where the CPI inflation rate will be in the medium term, rather than the current headline rate which captures price changes over the past 12 months.
The hawks on the committee such as Andrew Sentance have argued that a potential pick-up in inflation expectations poses an upside risk to CPI inflation. Yesterday’s evidence from the labour market suggests that the likelihood of expectations led wage-price pressure has diminished. There was a rise in UK claimant count unemployment and average wage growth fell back to 1.9%. So for now, nominal wage growth remains very weak.
Nevertheless, it should be remembered that 0.5% remains an unusually low setting for the policy rate, and the Inflation Report probably reflects the governor’s view to a greater extent than other MPC members. So a rate increase in May cannot be ruled out. Hence, it will especially important to focus on the release of the minutes of the last MPC meeting to see if more than two members voted for a rate increase. However, yesterday’s report indicates that expectations for immediate rate rises have been overstated.