Dr Andrew SentanceFormer MemberMonetary Policy Committee
Take Five: 5 reasons to worry Take Five: 5 reasons to worry about UK inflationabout UK inflation
Presentation to M&G Inflation ConferencePresentation to M&G Inflation ConferenceLondon, 4 October 2011London, 4 October 2011
Reasons to worry about UK inflationReasons to worry about UK inflation
• Inflation performanceInflation performance
• Global inflationary pressuresGlobal inflationary pressures
• SterlingSterling
• Persistent services inflationPersistent services inflation
• The MPCThe MPC
UK inflation significantly above targetUK inflation significantly above target
Source: Office for National StatisticsSource: Office for National Statistics
% per annum increase in consumer prices index
UK economic growthUK economic growth
* Weighted average of manufacturing and services output* Weighted average of manufacturing and services output
% per annum change in economic activity
Employment in UK recessionsEmployment in UK recessions
Source: Office for National Statistics, Labour Force SurveySource: Office for National Statistics, Labour Force Survey
Index of employment, 100 = cyclical peak
Number of quarters from employment peak
Rebound in nominal demandRebound in nominal demand
Source: Office for National StatisticsSource: Office for National Statistics
% per annum change in key measures of nominal demand
High inflation squeezing retail volumesHigh inflation squeezing retail volumes
Source: Office for National StatisticsSource: Office for National Statistics
% per annum growth in retail sales (3-month ave)
Global inflation on the riseGlobal inflation on the rise% per annum change in consumer prices% per annum change in consumer prices
Source: The EconomistSource: The Economist
Real oil and commodity pricesReal oil and commodity prices
Source: IMF and Thompson Datastream.Source: IMF and Thompson Datastream.
Deflated by US consumer price index; 2000=100Deflated by US consumer price index; 2000=100
0
50
100
150
200
250
300
350
1980 1985 1990 1995 2000 2005 2010
S&P GSCI Agriculture and Livestock index
S&P GSCI Industrial Metals index
Brent crude spot price
Global primary energy consumptionGlobal primary energy consumption
Source: BP Statistical Review 2010Source: BP Statistical Review 2010
Million tonnes oil equivalentMillion tonnes oil equivalent
2000
2500
3000
3500
4000
4500
5000
5500
6000
6500
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007
OECD
Non-OECD
The rise of AsiaThe rise of Asia
*: Includes Australia, China, India, Indonesia, Japan, Malaysia, Singapore, South Korea, Taiwan Province of China and Thailand.*: Includes Australia, China, India, Indonesia, Japan, Malaysia, Singapore, South Korea, Taiwan Province of China and Thailand.
Source: IMF World Economic OutlookSource: IMF World Economic Outlook
Percentage share of world GDP, current market prices and exchange ratesPercentage share of world GDP, current market prices and exchange rates
0%
5%
10%
15%
20%
25%
30%
35%
40%
1980 1990 2000 2010
US EU-27 Asia-pacific G10 *
Shares of world GDP and populationShares of world GDP and population
*: Apac G10: Asia-Pacific G10, including Australia, China, India, Indonesia, Japan, Malaysia, Singapore, South Korea, Taiwan *: Apac G10: Asia-Pacific G10, including Australia, China, India, Indonesia, Japan, Malaysia, Singapore, South Korea, Taiwan Province of China and Thailand.Province of China and Thailand.
Source: IMF World Economic Outlook, World Bank and Eurostat.Source: IMF World Economic Outlook, World Bank and Eurostat.
2010 figures2010 figures
US, 23%
EU-27, 26% Apac
G10*, 27%
Other, 24%
GDP at market prices
US, 5%
EU-27, 7%
Apac G10*, 46%
Other, 43%
Population
Prospects for 2011 and 2012Prospects for 2011 and 2012% per annum change in GDP, latest consensus forecast% per annum change in GDP, latest consensus forecast
* US, EU and 11 other major economies making up 85% of world GDP* US, EU and 11 other major economies making up 85% of world GDPSource: The EconomistSource: The Economist
World economic growthWorld economic growth
* EU, US and 11 other economies accounting for 85% of world GDP* EU, US and 11 other economies accounting for 85% of world GDPSource: IMF World Economic Outlook, April 2011, and The EconomistSource: IMF World Economic Outlook, April 2011, and The Economist
% per annum change in GDP in G-13 economies*
The global recovery in contextThe global recovery in context% per annum change in GDP% per annum change in GDP
* US, EU and 11 other major economies making up 85% of world GDP* US, EU and 11 other major economies making up 85% of world GDPSource: IMF and The EconomistSource: IMF and The Economist
Monetary policy, the global economy and Monetary policy, the global economy and inflationinflation
Global economy
Cost of imports
Demand
Pricing climate
Exchange rate
Domestic demand
Expectations and credibility
UK inflation
Impact of monetary policy
Sterling depreciation since 2007Sterling depreciation since 2007
Rebased to 100 in January 2005Rebased to 100 in January 2005
Source: Thompson Datastream and Bank for International SettlementsSource: Thompson Datastream and Bank for International Settlements
*: Effective exchange rate*: Effective exchange rate
70
75
80
85
90
95
100
105
110
2005 2006 2007 2008 2009 2010 2011
Euro-Sterling exchange rate
Sterling EER *
Average EER *, 97-07
Episodes of Sterling depreciationEpisodes of Sterling depreciation
Index, base year = 100Index, base year = 100
Number of years from start of periodNumber of years from start of period
Source: Bank for International SettlementsSource: Bank for International Settlements
50
60
70
80
90
100
110
0 1 2 3 4 5
1967-1971 1972-1977 1981-1986
1991-1996 2007-2010
Euro/UK inflation differential & exchange rateEuro/UK inflation differential & exchange rate
Source: Thompson DatastreamSource: Thompson Datastream
*: Euro-Sterling exchange rate is expressed as the deviation from its average over the same period.*: Euro-Sterling exchange rate is expressed as the deviation from its average over the same period.
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
0.3
-3.0
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
1997 1999 2001 2003 2005 2007 2009 2011
Euro-area/UK CPI differential (RHS) *
Euro-Sterling exchange rate (LHS) **
Euro/ sterling %
UK goods price inflationUK goods price inflation
Source: Office for National StatisticsSource: Office for National Statistics
% per annum change in goods prices
Persistently high services inflationPersistently high services inflation
Source: Office for National StatisticsSource: Office for National Statistics
% per annum change in consumer prices
Reasons to worry about UK inflationReasons to worry about UK inflation
• Inflation performanceInflation performance
• Global inflationary pressuresGlobal inflationary pressures
• SterlingSterling
• Persistent services inflationPersistent services inflation
• The MPCThe MPC
Large official inflation forecast errorsLarge official inflation forecast errors
Source: Bank of EnglandSource: Bank of England
Mean of forecast percentage annual increases in consumer pricesMean of forecast percentage annual increases in consumer prices
0
1
2
3
4
5
6
2007 2008 2009 2010 2011 2012 2013
May-09 Nov-09
May-10 Nov-10
May-11 Actual CPI inflation
Unemployment in UK recessionsUnemployment in UK recessions
Source: Office for National Statistics, Labour Force SurveySource: Office for National Statistics, Labour Force Survey
Unemployment rate, % of labour force
Number of quarters from employment peak
Capacity utilisation in UK economyCapacity utilisation in UK economy
Source: Bank of EnglandSource: Bank of England
Bank of England Agents’ scores relative to normal
Wage growth picking upWage growth picking up
Source: Office for National StatisticsSource: Office for National Statistics
% per annum growth in private sector average weekly earnings
What is wrong with the MPC?What is wrong with the MPC?
• Policy-setting no longer consistent with 2% inflation target Policy-setting no longer consistent with 2% inflation target and mandateand mandate
• MPC seems prepared to inject more stimulus even when MPC seems prepared to inject more stimulus even when inflation is more than double target levelinflation is more than double target level
• Poor forecasting record, yet forecasts critically underpin Poor forecasting record, yet forecasts critically underpin current policy judgements current policy judgements
• Benign neglect of the poundBenign neglect of the pound
• No track record of taking tough monetary policy decisions to No track record of taking tough monetary policy decisions to underpin credibilityunderpin credibility
• Dominated by internal consensus around GovernorDominated by internal consensus around Governor
ConclusionsConclusions
• UK inflation performance reflects structural problems in UK inflation performance reflects structural problems in current inflation target regimecurrent inflation target regime
• MPC has used its discretion to redefine inflation target MPC has used its discretion to redefine inflation target framework post-financial crisisframework post-financial crisis
• External members cannot effectively counter a strong External members cannot effectively counter a strong internal block dominated by the Governorinternal block dominated by the Governor
• There has been an overt policy of benign neglect of the There has been an overt policy of benign neglect of the pound, which has fuelled inflationpound, which has fuelled inflation
• UK monetary institutions and practice have an UK monetary institutions and practice have an inflationary bias – investors beware!inflationary bias – investors beware!