MNI INTERVIEW: Posen Sees Risk of More Persistent UK Inflation

The UK economy faces greater risk of persistent inflation than its G7 peers because Brexit has made inflation expectations less anchored and hampered the ability to tackle supply disruptions, making it likely the Bank of England will have to tighten policy more aggressively than markets are pricing, former Monetary Policy Committee member Adam Posen told MNI.

"There's less of a prospect for inflation to be transitory there," said Posen, now president of the Peterson Institute for International Economics, in an interview. "Given Brexit, the UK economy is fundamentally more vulnerable to shocks," including supply shortage inflationary pressures, he said.

Large economies like the United States, Europe and China are inherently more nimble in absorbing hits like the global supply chain crunch and temporary labor shortages in certain sectors, Posen said.

Countries around the world are feeling the pinch from a lack of agricultural and trucking workers, but that pain especially acute in Britain, Posen said. "In the UK, the same shock was worse because there was much more paperwork involved and a much more limited supply to draw on."

The UK's inflation rate, at a 3.1% annual rate in September, is not nearly as high as the United States' eye-popping 6.2% surge in October CPI. But the UK figure is expected to keep rising, with the Bank of England looking for a peak at 5% in the spring of 2022.

And, Posen said, the underlying reasons for the rise and the broader economic context are more worrisome there.

POLICY STRUGGLES

"Unlike the Fed or the ECB, the Bank of England fundamentally has less well anchored inflation expectations," he said. That was less of a factor when Posen was a Bank of England member, he added, because EU membership helped mitigate any upward pressure on inflation expectations.

"By being part of the European Union, there was more of an anchoring effect of how far the economy and policy could run off the rails," he said, noting his own belief that the BOE will struggle post-Brexit to deliver on stable low inflation, even though its intentions will be no less diminished.

Against that backdrop, Posen thinks the BOE will have to be more aggressive than market participants currently expect, raising interest rates by a total of 150 to 200 basis points, in order to restrain inflation expectations..

Posen believes the Bank will have to tighten "not just earlier but more than the Fed even though the level of inflation is currently lower" to fight the risk of inflation expectations becoming unanchored.

Markets were taken aback by a lack of BOE action in November following strong hints of a hike from Governor Andrew Bailey, in what Posen described as an unfortunate, if not particularly consequential, communications misstep.

"In the end it doesn't matter very much because they'll raise in December or February," he said, but accepted the pre-meet noise was unhelpful for future communications.

MISSING FISCAL

Two key inflation drivers in the U.S. economy, fiscal stimulus and a major labor market transition, are much less prevalent in the UK, Posen said. "In the U.S. we know part of it is fiscal," said Posen, noting that London did not follow up on its original relief package with more stimulus.

"The higher inflation they're getting is because they don't have the labor supply elasticity, they don't have the substitutability of sources, they don't have the resilience that they would have had as part of the European single market."

The UK is also not grappling with anything like the extent of job market shifts facing American workers, because furlough schemes like those in Europe made it easier for employees to keep their jobs.

PARTWAY BACK TO THE 70s

Britain has a much longer history of stubborn inflation than the United States or Europe, historically having faced repeated currency devaluation cycles and double-digit consumer price gains. Posen worries that backdrop may now be back into view.

"They're moving partway back to the 70s," he said, calling Britain's ability to maintain its inflation targeting regime staring in 1992 a "great triumph."

"They didn't get the kind of disastrous effects of devaluations that the UK had recurrently in the 60s, 70s and 80s. But now I feel that process has been partially reversed," Posen said.