Forecasting failures under Bailey have made inflation worse, admits Bank of England policymaker

Tim Wallace
Tue, 27 June 2023 

Andrew Bailey has faced widespread criticism for letting inflation get out of hand - TOLGA AKMEN/EPA-EFE/Shutterstock

The Bank of England’s poor economic forecasts have undermined its response to the cost of living crisis, extending the pain and hitting the institution’s credibility, a top policymaker has warned.

Swati Dhingra, an economist who joined the Monetary Policy Committee last year, said “a lot of the pain and the criticism, and the inaccuracy of monetary policy, could have been avoided had we had better data and statistics and analytical toolkits to be able to do some of these types of analysis better”.

Central banks “have not kept pace” with major changes in the economy since the 1970s, when the world was last struck with a crippling energy price crunch, she said in a speech at a UK Women In Economics Network event.

Dr Dhingra acknowledged that the Bank’s modelling “has taken a massive bashing” and said the institution faces a “historical moment” to get its analytical capabilities “in shape for the next big shock that arises, as well as to be able to mitigate whatever we can of this shock as it goes on”.

The Bank has admitted repeatedly underestimating inflation, both when prices started to surge in 2021 and 2022, as well as midjudging the stubbornness of cost increases through recent months as households have suffered in the face of a prolonged cost of living crisis.

Andrew Bailey, the Governor, this month admitted “we were wrong” on the tightness of the jobs market coming out of the pandemic and the subsequent impact on inflation, while the Bank has struggled to accurately predict price rises since then.

Mr Bailey said: “We still think the rate of inflation will come down but it is taking a lot longer than we expected.”

Dr Dhingra, who wanted to hold interest rates at 4.5pc this month but was outvoted in favour of a move to 5pc by a majority of the nine-strong MPC, said inflation is now at last set to fall quickly as cost pressures in supply chains fade and energy prices come down.

“We can start to feel a little bit reassured that there is some promising evidence out there that the producer price inflation (PPI) drop has been broad-based across the consumption basket,” she said.

There are a few areas where lower PPI reported by businesses is not feeding through to the shop shelves, including fruit, tobacco and beer.

However, at the same time, Dr Dhingra said the drop in energy costs is trickling through the economy while labour-intensive industries, including retail and hospitality, are “seeing a levelling off to some degree of wage inflation” which is important for keeping a lid on consumer prices.

Dr Dhingra said it was important nonetheless to have raised interest rates from December 2021 to show the Bank was taking inflation seriously.

She said: “The policy stance has needed to be tightened compared to the almost abnormal levels of 0.1pc interest rates that we had become used to before.

“This is really designed to insure against any kind of runaway domestic inflation, but the biggest issue is it is not going to be able to do anything about spot inflation, it is only going to have a lagged effect.”

This means that “its effects are not going to be felt until the end of this year in a big way, but there are some promising signals CPI inflation should ease”.

However, analysts at Capital Economics have said this will require higher interest rates, predicting that this will cause a recession in the UK.

The economists said: “Wage growth and core CPI inflation will only drop to rates consistent with the 2pc target if the Bank triggers a recession by raising rates from 5pc now to at least 5.25pc and keeps them at their peak until late-2024.”