–BOE Bean: MPC Has Chosen To Accept Above Target Inflation

LONDON (MNI) – A key question facing the Bank of England’s Monetary
Policy Committee is whether the economic “soft patch” evident in some
recent activity data is only temporary, BOE Deputy Governor
Charles Bean said in a speech Thursday.

With inflation running well above target and growth patchy, Bean
said the MPC had chosen to accept a period of above target inflation to
help facilitate the economic rebalancing that is needed. In the speech
he highlighted the slow pace of recovery in the wake of the financial
crisis, and gave no clear indication of when he expects the first hike
in Bank Rate to come.

Bean said that stripping out the extremely volatile construction
and oil and gas extraction numbers from the recent data “we are still
left with a picture of flattish underlying activity through the end of
last year and only modest quarterly growth of just 0.5% at the beginning
of 2011.”

The official data, hit by exceptional factors, have shown no net
growth in the UK economy over the fourth quarter of last year and the
first of this, and Bean says the underlying picture is one of soft
growth.

“Other indicators, such as measures of consumer and business
confidence and the reports from our Agents around the country, also
point to a slackening in the underlying rate of expansion around the
turn of the year,” Bean said.

“The crucial question is whether this just represents a temporary
‘soft patch’ of the sort often seen during the early stages of economic
recoveries, or whether it is instead the harbinger of a prolonged period
of slow growth,” Bean said.

The MPC, on balance, expects growth to pick up, but it is going to
be a slow process.

“The underlying picture is one of growth gradually picking up to
around its historical average rate, reflecting continued recovery in
investment and a higher contribution from net exports and, on the back
of that, some modest strengthening in consumer spending as we go through
next year,” Bean said.

He said research showed in the wake of financial crises “a
persistent output shortfall on average of 10%” and the projected growth
path in the BOE’s May Inflation Report “lies quite close to the average
experience from this sample of past banking crises.”

The MPC has stressed the need for economy rebalancing away from
private and public consumption towards investment and net exports.

Bean said net exports had so far been disappointing, with robust
growth in exports but with surprisingly strong import figures.

The hoped for economic rebalancing “is still at an early stage,”
Bean said.

He noted that household spending stagnated last year and said weak
spending figures had been expected.

“The sluggishness of consumer spending should hardly be a surprise.
Real post-tax labour incomes have been squeezed by a mix of low pay
growth and elevated inflation on the back of higher VAT, energy and
import prices,” Bean said.

He downplayed the significance of the latest, strong retail sales
numbers.

“With the squeeze on real pay likely to continue through this year,
it seems likely that consumer spending will remain subdued through this
year at least,” Bean said.

Above Target Inflation Accepted By MPC

While growth in the wake of the financial crisis has been sluggish,
inflation has moved to more than double the MPC’s 2.0% target and come
in consistently above the MPC’s central forecasts.

Bean said one reason for this is that the impact of import prices,
following sterling’s depreciation, has been greater than the MPC
thought, with import prices having added as much as 6.5% to CPI.

“The current elevated inflation rate of 4.5% can be largely
accounted for by the effects of energy and import prices and VAT: energy
prices and VAT are probably each contributing around one percentage
point to current inflation, and non-energy import prices around double
that,” Bean said.

The BOE’s May Inflation Report put a roughly equal chance of CPI
falling back to target at the end of the forecast horizon.

Bean said the big picture was that the next few years would be
difficult for households and those in the consumer sector, with a
reduction in UK living standards.

Monetary policy, however, has been set to help cushion some of the
pain.

“While monetary policy cannot ultimately insulate us from the
associated hit to our living standards, it can affect the adjustment
path. In particular, the MPC’s chosen approach has been to accept a
temporary period of above-target inflation, rather than seeking to hold
inflation as close to the 2% target as possible at all times,” Bean
said.

He said hitting the 2% target “would have required a markedly
higher level of Bank Rate and with it most probably a somewhat higher
level for sterling.”

“That would have moderated some of the external inflationary
impulses facing us, but would also have depressed activity and pay even
more and retarded the requisite re-balancing of the economy,” Bean said.

He said this approach was consistent with the MPC’s mandate.

–London bureau: +4420 7862 7491; email: drobinson@marketnews.com

[TOPICS: M$B$$$,M$BDS$,MT$$$$,M$$BE$]