Greene urges proactive policy on energy shock inflation risks
Bank of England policymaker Megan Greene warned that the latest energy shock from the Middle East conflict poses significant inflation risks. Speaking at the University of Derby, she called for a proactive monetary policy response to prevent persistent second-round effects.
Successive shocks, proactive response
Megan Greene identified the Middle East conflict and the effective closure of the Strait of Hormuz as the latest "energy shock," following Covid-19 lockdowns and Russia's invasion of Ukraine.
She noted that such negative supply shocks push up inflation and reduce economic activity.
While central banks traditionally "look through" these, Greene believes a more proactive approach is needed to lean against inflation when an economy has been hit by successive supply shocks.
This is crucial to prevent "second-round effects" from taking hold through shifts in wage- or price-setting processes.
Conclusive evidence on these effects takes time to emerge, but policymakers must make judgments and act before full verification, given the lags in monetary policy transmission.
She highlighted that the April CPI release already showed a significant rise in fuel prices, with forecourt prices up around 15% on the month and 23% year-on-year.
Expectations drive persistence
Second-round effects primarily propagate through changes in wage and price setting.
Households demand higher nominal wages to protect purchasing power when inflation expectations rise, while firms raise prices beyond direct cost increases to maintain margins.
Inflation expectations are "terribly important" (Powell, 2021) in this process.
The size and type of energy shock also matter, with gas shocks tending to have broader and more persistent effects on UK inflation than oil shocks.
Bank staff analysis indicates that household inflation expectations become more sensitive to global oil price shocks above a 3.1% inflation threshold.
Moreover, expectations are highly responsive to salient items like energy and food, with media coverage amplifying this sensitivity.
A new norm demands new thinking
Greene's speech effectively highlights the evolving challenge of persistent supply shocks, moving beyond traditional 'look through' approaches.
Her call for proactive policy, even before full evidence of second-round effects, signals a critical shift in central bank thinking.
This pragmatic stance acknowledges the heightened risks of de-anchored expectations in an era of successive disruptions.