Pill: Risk Management Needed To Ensure High Inflation Doesn't Get Embedded

Q: When can we expect the BOE's decision-making to be more in line with its forecasts?

• A: If you use the standard forecasting framework with linear models based on inflation being close to 2% (which is generally the modal forecast) - if things play out consistent with futures pricing in energy, and see the economy move in line with that forecast, we would expect inflation to fall significantly in line with the forecast. We would also expect to see wage pressures fall.
• The risk - which is embedded in the skew - is that having inflation so high ("a perfect storm" of disturbances to the economy) has created non-linearities in the economy.
• Need to make sure domestic inflation that is controlled by monetary policy moves to be consistent with the target. Think risks are skewed to embedding more inflation than the linear models from the forecast suggest.
• As inflation falls, we can move back to a more traditional approach of looking at the modal inflation forecast 2 years out. Until we are reassured, risk management needs to ensure we don't accommodate some kind of underlying higher inflation becoming embedded.