The Bank of England met last night and did precisely what I expect the Fed to do, disappointing hawks:
The near-term outlook for inflation is muted and the falls in energy prices over the past few months will continue to bear down on inflation at least until the middle of next year.
Nonetheless, a range of measures suggest that medium-term inflation expectations remain well anchored. There is little evidence in either wage settlements or spending patterns of any deflationary mind set among businesses and households. Sterling has appreciated by 3½% since May and 20% since its trough in March 2013.
The drag on import prices from this appreciation will continue to push down on inflation for some time to come, posing a downside risk to its near-term path in particular. Set against that, the degree of slack in the economy has diminished substantially over the past two and a half years.
The unemployment rate has fallen more than 2 percentage points since the middle of 2013, and the ratio of job vacancies to unemployment has returned from well below to around its precrisis average. Robust private domestic demand is expected to be sufficient to eliminate the remaining margin of spare capacity—judged to be around ½% of GDP—over the next year or so, despite the continuing fiscal consolidation and modest global growth.
The closing of the output gap, in turn, should generate the rise in domestic costs necessary to counterbalance the drag on price pressures from sterling, and so return inflation to the target in the medium term.
The likely timing of the first Bank rate increase is drawing closer. However, the exact timing of the first move cannot be predicted in advance; it will be the product of economic developments and prospects. In short, it will be data dependent.
The MPC will monitor developments relative to the forecast in particular wage growth, productivity, core inflation, import prices and risks to the international environment. The path of rates is much more important than the precise timing of the first increase.
Given the likely persistence of the headwinds facing the economy the MPC expects Bank Rate increases, when they come, to be gradual, and to be limited to a level below past averages.
By acting in this manner, the MPC can secure the expansion and build on the hard-won gains of recent years.
The US unemployment rate is slightly lower than the UK and inflation a little higher but the shadow slack in its labour market is larger. Within the accepted bounds of central bank action, this is exactly what the Fed should do.
