BoE’s Broadbent warns of rising UK import prices from weak pound

Posted on November 18, 2016

The UK economy faces a period of significantly higher import prices on the back of a record slump in the pound, one of the deputy governors of the Bank of England has said, hinting policymakers were less willing to tolerate a sterling-induced inflation rise.

The pound’s 11 per cent fall against the dollar in the two days after the Brexit vote marked the sharpest depreciation since 1967, said Ben Broadbent, who warned the weakening exchange rate would exert “significant upward pressure on import prices”.

Input prices faced by UK manufacturers have soared to decade-highs in the months following the referendum. Without sustained rises in wages, higher headline inflation has raised concerns that consumer spending is set to be squeezed next year.

The BoE changed tack in its latest economic outlook this month, saying it was less willing to tolerate a sustained inflation overshoot in the wake of sterling’s 20 per cent decline against the dollar this year.

Mr Broadbent said there was a large lag time between the sterling-driven rise in import prices to consumers prices, “long enough, in principle, for monetary policy to do something about them”:

It’s not clear policy is impotent in the face of such events; nor is it clear, even in the absence of “second-round” effects on inflation expectations, that policymakers should be indifferent to them

According to one of the BoE’s models, it would take a 0.5 percentage point rise in interest rates to prevent inflation from rising in the wake of a sharp depreciation.

“It’s technically feasible, at least according to this model, to keep inflation pretty close to target after a significant depreciation in the exchange rate. It’s just rather costly in terms of unemployment,” he said.

UK inflation currently stands at 0.9 per cent but is forecast to climb to as high as 2.7 per cent over the next two years.

Summing up the trade-off facing the BoE, Mr Broadbent said policymakers’ tolerance of higher inflation “depends in part on ‘the scale of the shortfall in economic activity below potential’”. He said:

The MPC would be less inclined to accommodate above-target inflation if it didn’t also expect demand to fall slightly short of that supply potential; it would be able to do more prevent any rise in unemployment if it weren’t for the inflationary pressure brought about by the fall in the currency.

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