MNI INSIGHT: BOE’s Falling Energy Price Scenario Fades Away

Bank of England policymakers are once again placing more weight on their central inflation forecast, after the Russian invasion of Ukraine rendered a more optimistic alternative scenario based on a fall in energy prices in line with market expectations much less relevant.

While the BOE’s inflation-forecasting convention has been to use market energy price curves for the first six months and then to assume prices stay flat thereafter, the November Monetary Policy Report highlighted an alternative, market-based projection showing prices easing, as did Governor Andrew Bailey during the press conference.

The central projection showed CPI inflation still above target at 2.2% in two years’ time before dipping just below to 1.9% after three years. In contrast the measure using market energy curves whose use was emphasised by Bailey showed it dropping to 1.7% in two years and staying there.

The alternative measure was already losing prominence in officials’ public statements by February, when it showed CPI inflation around 0.75 percentage point below the 2% target two and three years ahead, even as fears over a possible war in Ukraine had begun to push up energy prices.

MARCH MEETING

With the next full forecast round not due until May, the message from Monetary Policy Committee members ahead of their next policy announcement on March 17 has been to focus on fundamentals rather than to be drawn into guessing games over the impact of the Ukraine crisis on inflation.

In remarks at a Cleveland Fed event, Catherine Mann highlighted how expectations of higher prices are becoming embedded in the UK in a way not being observed in the euro area or even the U.S., with British market expectations showing inflation persisting above target despite anticipated front-loading of rate hikes. Fellow MPC member Michael Saunders also highlighted concerns about de-anchored inflation expectations.

In a speech last week at the National Institute of Economic and Social Research, the MPC’s Silvana Tenreyro said that if policy was set on the alternative, flat energy price assumption it was “likely to be more robust to further volatility.”