Speaking at an event given by the Economic Policy Symposium at the weekend, he said that correlations of headline CPI largely reflect price level shocks such as those to oil. “Core inflation rates exhibit much less co-movement but rather vary with increasingly divergent underlying economic conditions.”
Mr Carney added that the stance of monetary policy reflects these differences.
“After adjusting for unconventional policy there’s greater monetary policy divergence than implied by a simple eyeballing of the currently highly synchronised global rates cycle. And there remains the prospect of a further widening.
“In other words, domestic economic conditions – conditions affected by domestic monetary policy – still very much matter.”
Mr Carney said that none of this diminishes the considerable challenges of returning inflation to target in the face of global developments.
“There are profound secular and cyclical disinflationary forces at work in the global economy, and for economies like the UK, their impact is being reinforced by exchange rate movements which will drag inflation down further at the policy horizon.
“Moreover, as events of the past few weeks have reminded us, a variety of global factors can affect global financial conditions and influence the neutral rate of interest.”
Mr Carney said that central banks must take these ‘disparate confounding dynamics’ (DCDs) into account when setting policy.
“Even for those economies with the strongest recoveries and the best functioning financial systems, they mean that the policy rates consistent with returning inflation to target will likely need to rise in a gradual fashion and to a limited extent despite robust domestic demand and firming domestic costs. For the UK at least, global DCDs influence but do not dictate policy.”
In his concluding remarks, Mr Carney said: “First, to the extent to which lower Chinese demand for commodities imparts a positive terms of trade and real income shock on the UK economy, the MPC can look through the temporary disinflationary impact on headline inflation and concentrate on potentially more persistent effects through trade and financial channels.
“In that regard, a potential further material slowing of growth in China and more broadly in non-Japan Asia, particularly if coupled with material and persistent exchange rate depreciation, could impart further imported disinflationary pressures over the policy horizon.”
Additionally, Mr Carney said that a persistent tightening of domestic financial conditions as a consequence of increased global risk aversion could re-introduce a headwind to growth and inflation over the medium term.
However, he added that these are possibilities, not certainties, and that their evolution needs to be monitored, not taken for granted.
“Members of the MPC will continue to monitor a wide range of indicators of domestic economic momentum, domestic costs, and importantly given our discussion today, the outlook for imported disinflation (as part of core CPI inflation amongst others) in determining the precise timing and path for bank rate.”
ruth.gillbe@ft.com
