Bank of England Inflation Report Weakens the Pound

The Bank of England today extended its forecast for inflation to fall back below its 2% target to the first quarter of 2016 and weakened growth projections but maintained that they are ready to add extra stimulus measures if the economic recovery fails to pick up speed, triggering weakness in the pound sterling.

The market had originally expected the bank to show inflation above the 2% level until early to mid 2015, and so today’s extension to 2016 is much longer than expected. The Central Bank forecast inflation to likely be 0.5% higher than originally projected in two years time to 2.3%, marking a stark increase in a relatively short space of time. Inflation is now set to peak at 3.2% in the third quarter of this year.

The key aspect from the report is a continuing divorce of priorities at the Bank of England from inflation targeting to supporting the economic recovery.

The Bank remains between a rock and a hard place in trying to strike a balance between the rising pressures of inflation and supporting the economic recovery. Clearly right now the Bank is firmly weighting its actions to the latter at the expense of inflation but the question is how long can this last? The upward revisions to inflation merely over the past six months are alarming especially when put alongside anaemic wage growth. The Bank is now facing time pressures from waiting for output – and indeed supply side reforms – to increase to a level that may allow it to act on curbing inflation. This is the new normal for the BoE.

For now, the Bank seems comfortable in ignoring this discomfort in the belief that the risks of tightening monetary policy right now would disrupt a recovery which Mervyn King states has shown some encouraging signs.

So is this inflation report a game changer? No. The key sentiment to take away is that it reaffirms the Central Banks commitment to accommodative steps to strengthen the recovery at the expense of inflation in the medium term.

The Pound Weakens
The pound sterling took the brunt the reaction as the Inflation Report showed that the Central Bank remains happy to keep acting on the stimulus front when required. The pound fell 60 pips against the dollar and 50 pips against the euro within 30 minutes.