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The inflation report is a semi-annual occurrence for Threadneedle Street – essentially it sets out the bank’s view of inflation in coming quarters, using the now infamous ‘fan charts’ that provide a variety of possibilities as to the predicted level of inflation. It is designed to give the bank as much wiggle-room as possible when highlighting the expected range of outcomes, but inevitably the consensus view will shine through.
When it comes to interest rates, Mr Carney will almost certainly stick to his ‘limited and gradual’ mantra that has become his standard response when pressed on the subject of UK interest rates. His delicate task involves sending the signal that the bank will not let inflation get out of hand, but nor will it raise rates too quickly or too steeply in a fashion that risks derailing the still-fragile economic recovery.
In addition, Mr Carney is likely to end up sending hints about the bank’s perception of the broader economy, including GDP growth and unemployment rates. The bank was caught out this year when unemployment dropped at a faster-than-expected pace, resulting in the 7% unemployment goal being dropped from the bank’s forward guidance policy. This time, the bank may cut its unemployment forecast once again, while at the same time reducing its short-term outlook for inflation. This would give it the necessary room on interest rates – weaker inflation reduces the risk that the UK economy is about to receive a sudden ‘price shock’, where the price of goods accelerates rapidly.
UK CPI growth still weak
The chart below shows the change in UK CPI since the early days of 2001. From this it is obvious that price growth continues to be weak, and that the recent turnaround does not change the general trend. This illustrates the bank’s problem nicely – CPI can rise rapidly, as was the case in 2009 and 2010, but it is hard to predict, and the BoE could very easily be left behind the curve.