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BoE's Haldane on why inflation 'tiger' could be hard to tame

BoE's Haldane on why inflation 'tiger' could be hard to tame
 Bank of England chief economist Andy Haldane

Inflation in the UK could rise sharply and remain persistently higher over the coming decades, according to the Bank of England's chief economist

In a speech published by the Bank of England last week, Andy Haldane said he expected inflation to reach its 2 per cent target around the middle of 2021 as the one-off effects of Covid-19 are "washed out".

Inflation, currently at 0.9 per cent, has been below its 2 per cent target since August 2019 and has been entrenched at a lower level for several years.

Haldane pointed out that, having averaged around 10 per cent in the 1970s and 1980s, inflation fell to around 5 per cent in the 1990s, just below 3 per cent in the 2000s and around 2 per cent in the 2010s.

But he cautioned against complacency, predicting this could change in the near future due to rising demand as economies re-open following the coronavirus pandemic.

Haldane said: "My judgement is that we might see a sharper and more sustained rise in UK inflation than expected, potentially overshooting its target for a more sustained period, as resurgent demand bumps up against constrained supply."

He described inflation as a "tiger" that had been stirred by the events of 2020.

Haldane warned: "For me, there is a tangible risk inflation proves more difficult to tame, requiring monetary policymakers to act more assertively than is currently priced into financial markets.

"People are right to caution about the risks of central banks acting too conservatively by tightening policy prematurely. But, for me, the greater risk at present is of central bank complacency allowing the inflationary (big) cat out of the bag."

Output gaps

The rate of inflation in any economy is heavily influenced by the output gap, which is the difference between the potential level of growth an economy can achieve in normal conditions, and the level actually being achieved. 

As long as economies are operating substantially below their rate of potential, inflation should not take hold, because, with more supply than demand in the economy, there is no capacity for prices to rise.

Haldane says the output gap in the UK, as brought about by the pandemic, is lower than the output gap  during the global financial crisis because while some sectors saw demand plummet, others saw it rise sharply.

The tech-heavy Nasdaq index, which does best when inflation expectations are low, has started to under-perfom relative to the FTSE 250, which tends to do best when inflation expectations are high

Haldane added that the response from central banks to the pandemic - such as cutting interest rates to the historically low level of 0.1 per cent - coupled with increased spending by the government has far exceeded the response to the financial crisis.

This means it is possible policy makers might inject too much stimulus into the system, which means economies start to operate at above the level of their long-term potential, or overheat, which causes higher inflation.