The governor of the Bank of England has conceded there are “very big lessons to learn” in setting monetary policy after the central bank failed to forecast the recent rise and persistence of inflation.
Along with other members of the BoE’s Monetary Policy Committee, Andrew Bailey told the House of Commons Treasury select committee on Tuesday that the bank’s own forecasting model was not delivering accurate results and the committee had reduced its role when setting interest rates.
“The reason we are not following ‘the model’ is because there are asymmetric effects [in the BoE’s view of the path of inflation] . . . We have taken a conscious decision to aim off [the model’s predictions],” the governor said.
He added inflation was likely to fall more gradually from March’s 10.1 per cent rate to the BoE’s 2 per cent target than the model had predicted.
Instead of using the model’s results, Bailey said the BoE’s work was now to think hard about “how we operate monetary policy in the face of very big shocks”. He added: “We’ve got to get on top of it and get inflation down.”
The BoE’s main forecasting model largely assumes that inflation will drop away as quickly as it appeared and the MPC has increasingly tweaked its results to override this.
Officials say they now believe wages and prices will continue to rise faster for longer than the model’s central forecasts.
While the BoE’s central forecast is for inflation to fall well below 2 per cent in 2025, the MPC thinks there is a 50:50 chance it will not drop below the target.
Bailey refused to discuss whether interest rates, which the BoE raised to 4.5 per cent this month, would rise further. “I can’t tell you that we’re near to the peak or at the peak, but we’re nearer to the peak,” he said.
His comments on the difficulties of forecasting inflation came alongside similar remarks from other MPC members, who all vote independently when the committee sets interest rates.
Chief economist Huw Pill said the bank’s economic models had failed to cope with the recent extreme shocks to energy and food prices because they were based on periods without such shocks.
He added that the MPC could not rely on looking at past episodes of high inflation in the 1970s and 1980s because too many other factors influencing the economy had changed.
Catherine Mann, an external MPC member, said she had voted for higher interest rates than the majority on the committee because she expected the big rises in inflation to lead to higher wage demands and to encourage companies to try to make price increases stick.