Bailey: Mideast conflict shifts UK inflation outlook
Bank of England Governor Andrew Bailey discussed the central bank's flexible inflation targeting framework in light of the Middle East conflict. He outlined how monetary policy will navigate the resulting energy price shock and its impact on UK inflation.
Energy shock pushes up UK inflation
Governor Bailey highlighted that the Middle East conflict has significantly altered the UK's inflation outlook.
Before hostilities in February, inflation was projected to fall to the 2% target from April, with further easing of monetary policy 'on the cards'.
However, April's inflation came in at 2.8%, 0.8 percentage points higher than expected due to rising fuel prices.
Inflation is now likely to increase further this year as utility bills rise and higher costs are passed through supply chains.
Bailey noted that monetary policy cannot prevent higher energy prices from affecting households and businesses, but must ensure inflation does not become embedded, aiming for a return to the 2% target in the medium term.
The Bank Rate was held at 3.75% at the most recent meeting, an active choice given the range of possible outcomes.
Navigating the flexible mandate
The Bank of England operates with an independent monetary policy mandate, established by the 1998 Act, targeting price stability with a 2% inflation goal.
This target is 'flexible', allowing the Monetary Policy Committee (MPC) to manage a trade-off between the speed of returning inflation to target and avoiding undesirable output volatility.
The MPC exercises 'constrained discretion', adapting its policy response to specific economic conditions and shocks.
This framework, which avoids predetermined rules, is crucial for building resilience into the inflation targeting process and securing the nominal anchor in an unpredictable world.
Adaptive policy for a volatile era
Bailey's speech highlights central banks' immense challenge in a volatile world, where external shocks constantly test policy.
'Constrained discretion' and scenario planning pragmatically admit rigid rules fail during unprecedented events.
This complex, adaptive approach is the only credible path to price stability amidst profound uncertainty.