MNI INTERVIEW: BOE Overweights Firms' Easing Price Plans-Weale

The Bank of England risks placing too much emphasis on surveys showing declines in firms’ expectations for setting prices as it discerns falling inflationary pressures and moves towards monetary easing, former two-term Monetary Policy Committee member Martin Weale told MNI.

Minutes of the MPC’s May meeting placed weight on the Bank’s agents’ business contacts expecting lower pass-through of higher labour costs to prices, but Weale said members would be wise to pay attention to still-elevated gains in wages. (See MNI POLICY: BOE Split Over Measures Of Inflation Persistence)

"I think if price expectations hadn't come down, there would be greater grounds for concern. But, the issue that was never clear to me, was whether what was happening in the labour market was important, or was it firms' price expectations? Now, what happens in the labour market ... is a sort of realisation of expectations," he said in an interview.

Annual growth for regular earnings in the first quarter was 6.0%, still elevated by recent historical standards, noted Weale, now a professor at King’s College, who has carried out extensive research into firms' survey based-pricing intentions and expectations. He is skeptical as to how much weight should be placed on such measures and doubts whether they alone can justify monetary easing.

WAGE PRESSURE CONTINUES

"There has been progress with wages. They're down from eight and a half percent. ... maybe this will appear by the summer, but I would want to see wage pressure easing further before I was prepared to make a [rate] reduction," he said.

Labour market developments "are an indicator of people's views of underlying inflation,” he said. “While that stays high, I think the implication is either that the labour market is very tight despite the restrictive monetary policy, which is an argument for not bringing Bank Rate down, or alternatively that ...those increases in labour costs will feed through into higher prices, whatever firms say they expect.” (See MNI INTERVIEW: Better ONS Data Suggest Easing UK Labour MarketMarket)

When responding to the bank’s agents’ questions about how much they will boost wages, businesses "have to put their money where their mouth is, whereas the answers they give to expectations surveys, you can say anything you like." Weale said.

In his own work and in research conducted with current and former Bank economists, including Lena Boneva and Tomasz Wieladek, Weale has come up with divergent correlations between firms' expectations and prices, with a low of around 0.3.

"If I do estimate that differently, I get rather higher numbers, like naught point eight or naught point nine. And essentially, the issue is whether you allow for the fact that expectations may be endogenous," Weale said, using endogeneity to refer to the way firms form expectations as part of the business process.

BERNANKE REVIEW

His research found that one-year ahead inflation expectations were more sensitive to past movements than two-year ahead expectations "so that suggests that actually long-term expectations have stayed anchored, or haven't moved around too much, and that's obviously a good thing."

Weale endorsed the view of former Federal Reserve Chair Ben Bernanke in his review of BOE forecasting procedures that the Bank's central model should no longer assume that inflation expectations automatically return to the 2% target. (See MNI INTERVIEW: BOE Models Can Ditch 2% Inflation Expectations)

"The experience for the last three years was that it was a lot of work to ensure that expectations did stay reasonably anchored," and the 2% anchor "shouldn't be seen as a strong pull, because at times of high inflation, people are likely to wonder whether the Bank ... actually means it," he said.