UK inflation risks have increased: MPC member

Bank of England policymaker and MPC member Megan Greene has warned that the conventional wisdom that central banks should look through supply shocks needs to be reconsidered, and that we are entering an age in which supply shocks are likely to be more frequent and severe, driven by factors like climate change and geopolitical tensions.

Speaking at the Adam Smith Business School at the University of Glasgow this week, Greene added that the risks to the UK’s inflation outlook have shifted to the upside.

“I think there are two main reasons to believe the supply side of the UK economy may have undergone a structural shift. Productivity growth in the UK has been weak in recent years, but even more so in recent quarters,” she said.

“In our forecast, we expect it to revert to historical norms over the forecast period. This would represent a rapid recovery, and I think the risks are firmly to the downside. Second, UK 16yo+ employment fell rapidly during the pandemic and still remains 1 percentage point below its pre-pandemic peak.”

Given ongoing issues with the ONS Labour Force Survey, it is particularly difficult to determine how much of this is due to a rise in inactivity versus unemployment, Greene said.

“If higher inactivity is a significant factor, that would represent a negative labour supply shock. Bank staff have shown that such shocks tend to generate more inflation persistence than other kinds of adverse supply shocks.”

Greene noted UK headline CPI inflation has been generally above target for over four years and rising for about a year, and that the year-long tick up in inflation puts the UK in stark contrast with its developed economy peers.

She added that the current uncertainties and risks facing the economy meant it may be better to ‘skip’ rate cuts rather than lower them quickly.

“The policy path produced by the model implies a policy reversal that involves hiking Bank Rate in the near-term before pivoting back to cuts. I place a substantial premium on avoiding such policy reversals, as they threaten central bank credibility.

“A more restrictive stance that takes this aversion to policy reversals into account could, in my view, instead mean skipping cuts.”

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