MNI INSIGHT: Inflation Expectations A Fuzzy Indicator For BOE

By David Robinson

     LONDON (MNI) - The Bank of England is likely to regard any post-Brexit

shifts in headline inflation expectations with caution as it considers its

monetary policy response, as its recent research indicates that many of those

surveyed for the data were unable to provide an answer while others appear to be

replying according to widely differing criteria.

     Market-based UK inflation expectations have shifted sharply higher over the

past 12 months even as eurozone and U.S. measures have declined, but the BOE's

own inflation expectations survey found that a significant proportion of the

population say they simply do not know where inflation is heading.

     If sterling depreciates further due to a no deal Brexit or political

turmoil, the BOE's Monetary Policy Committee could find itself having to manage

the trade-off between tolerating above-target inflation and supporting already

weak economic activity.

     Inflation expectations are an important policy guide. But small shifts in

the aggregate measure might be just noise.

     MPC member Silvana Tenreyro noted in a speech in July that while long-term

inflation expectations had increased since the 2016 EU referendum, the BOE

surveys showed this masked a rise, from 34% to 44%, in those answering they had

"no idea" what prices would do.

     These were often respondents with lower incomes. As wage takers with little

freedom to shift between saving and consumption their significance from a

macro-economic viewpoint is diminished, but other types of respondents also

answered surveys in ways which were harder to assess than the headline

expectations data might suggest.

     Companies filling in CBI surveys mingle their views on the likely path of

input and output pressures facing their businesses with estimates of

economy-wide inflation. To add to the confusion, not only is the headline CPI

target measure in widespread use in the UK but so is the older RPI one, which

runs around 0.8 points above CPI, making it unclear which measure respondents

are following.

     Two previous episodes which resulted in a precipitous decline in sterling,

the June 2016 EU referendum and the Global Financial Crisis, showed that changes

in inflation expectations are hard to predict.

     Ahead of the June 2016 EU referendum, the BOE's Inflation Attitudes Survey

indicated that the public's median expectation for year-ahead price increases

was 2.0% and this only nudged up to 2.2% by August 2016 before jumping to 2.8%

by November. In August 2008, a month before the collapse of Lehman Brothers,

12-month expectations were running at 4.4%, before sagging to 2.8% by November,

and 2.1% in February 2009. In the most recent survey, in August this year,

12-month expectations were 3.3%.

     A June BOE working paper, by Roland Meeks and Francesca Monti, neatly

summed up the shortfall in the traditional policy makers' approach of focussing

on a single, average inflation expectation.

     "Central banks' preoccupation with inflation expectations has been half

right. Well-anchored expectations underpin the ability of monetary policy to do

more to respond to trade-off inducing shocks .. But expectations need to be

understood in the plural, not the singular," they said.

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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