MNI: BOE Warns Permanent Covid Damage May Be Greater

Bank of England Monetary Policy Committee members warned inflation could take longer to rise to target, growth could be weaker and unemployment higher than in the Bank's central forecast in their August Monetary Policy Report (MPR).

Giving evidence to the Treasury Select Committee, Governor Andrew Bailey and colleagues fleshed out downside risks to August's central projection, warning that enduring economic scarring could be greater than they had assumed and unemployment higher with employees lacking the skills to switch to new growth sectors.

The August MPR's central projection showed, initially, a rapid recovery in activity with inflation rebounding from near zero to just above its 2.0% target at the end of the three-year forecast.

"There is a material risk in my view that it could take several years for the economy to return to full capacity and inflation to return sustainably to target, even with monetary policy at its current settings," MPC member Gertjan Vlieghe stated in written evidence.

If the Covid-19 pandemic persists patterns of consumption, employment and investment will shift, resulting in some sectors, such as those based on social spending, never returning to previous activity levels.

Bailey said structural change could lead to "longer term dislocation of the economy, and it can lead to longer term unemployment and the raising of the natural rate of unemployment."

DOWNWARD SKEW

The August MPR projections had a hefty downward skew but much commentary focussed on the relatively upbeat modal, or most likely, path. This showed headline CPI inflation averaging around 0.25% in the latter part of 2020 before reaching 2.0% in around two years, with GDP surpassing ipre-Covid levels by the end of 2021.

In the central forecast around 1.5% of GDP was assumed to be lost due to long-term scarring but Bailey noted "a huge amount of uncertainty around that."

Deputy Governor Dave Ramsden said the MPC had assumed that once the Covid shock was over GDP would be permanently 1.5% lower, but that "all the risks are really that that number will be greater than 1.5%."

While the MPC had allowed for some persistent labour market mismatch there were other risks, such as that of a permanent shock to commercial real estate from increased home working.

"Will that add up to a less productive or more productive economy? That is an open question," Ramsden said.