BoE admits ‘very big lessons to be learnt’ from failing to forecast rise in inflation

The governor of the Bank of England has admitted that there are “very big lessons to learn” in setting monetary policy after the central bank failed to predict the recent rise and persistence of inflation.

Along with other members of the BoE’s monetary policy committee, Andrew Bailey told the House of Commons treasury committee on Tuesday that the bank’s own forecasting model was not producing accurate results and that the committee had reduced its role in setting interest rates.

“The reason we don’t follow the ‘model’ is because of asymmetric effects[in the BoE’s view of the path of inflation]. . . We made a conscious decision to target [the model’s predictions]said the governor.

He added that inflation is likely to gradually decline from March’s 10.1 percent rate to the BoE’s 2 percent target, as predicted by the model.

Rather than using the model’s results, Bailey said the BoE is now working to think carefully about “how we operate monetary policy in the face of very large shocks”. He added: “We need to get past this and reduce inflation.”

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The BoE’s main forecast model largely assumes that inflation will fall as fast as it has emerged, and the MPC has increasingly adjusted its results to override this.

Officials say they now believe wages and prices will rise faster than the model’s central projections for a longer period.

While the BoE’s central forecast is for inflation to fall well below 2 percent in 2025, the MPC says there is a 50:50 chance that it will not fall below the target.

Bailey declined to discuss whether interest rates, which the BoE raised to 4.5 percent this month, would rise further. “I can’t say we’re close to the top or the top, but we’re closer to the top,” he said.

In addition to his comments about the difficulty of forecasting inflation, there were similar comments from other MPC members, who all vote independently of each other to set interest rates.

Chief economist Huw Pill said the bank’s economic models could not cope with recent extreme shocks to energy and food prices because they were based on periods when there were no such shocks.

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He added that the MPC cannot rely on past episodes of high inflation in the 1970s and 1980s because too many other factors affecting the economy have changed.

Catherine Mann, an outside member of the MPC, said she voted for higher interest rates than most of the committee because she expected a sharp rise in inflation would lead to higher wage demands and encourage companies to try to hold on to price increases.