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Sterling, not spare capacity, key for UK inflation: BoE's Forbes
June 16, 2017 / 4:15 PM / 6 months ago

Sterling, not spare capacity, key for UK inflation: BoE's Forbes

LONDON (Reuters) - The Bank of England policymaker who has led the charge for higher interest rates said on Friday the long-term effect of a fall in sterling in boosting British inflation was commonly underestimated in the BoE’s main economic models.

FILE PHOTO: A general view shows the Bank of England in the City of London, Britain April 19, 2017. REUTERS/Hannah McKay/File Photo

Kristin Forbes - who leaves the Monetary Policy Committee at the end of the month - said factors commonly believed to keep a lid on inflation, such as low public inflation expectations and a spare capacity in the economy, had only a limited effect.

“These results have a number of implications for monetary policy,” she said in the conclusion of a paper written with two other BoE researchers.

Forbes’s views on the factors driving inflation may have proven influential earlier this week when two other MPC members unexpectedly joined her in voting for higher interest rates - though the majority opted to keep rates at 0.25 percent.

British inflation jumped to its highest in nearly four years last month, at 2.9 percent - a bigger rise than the central bank had predicted just a few weeks earlier, and one driven in part by the pound’s tumble since last year’s Brexit vote.

In the minutes of this month’s policy decision, the central bank said it expected inflation would rise above 3 percent after a further fall in sterling after Prime Minister Theresa May failed to win a majority at last week’s election.

In the past the BoE has typically looked beyond surges in inflation driven by a weak currency, saying they typically prove short-lived. But Forbes said analysis of inflation since 1984 showed a weaker pound played a more lasting role.

“The exchange rate is significantly correlated with movements in the slow-moving, persistent trend (in UK inflation),” Forbes wrote in the abstract of the paper.

Global commodity prices also had a big influence on inflation in Britain’s small, open economy, she said.

“Other variables emphasized in standard inflation models - such as slack and inflation expectations - may also play some role, but ... the magnitude of their effects is substantially smaller,” she added.

Models which relied on hard-to-measure concepts such as slack and inflation expectations should be “used cautiously”, she added. Significant slack or low inflation expectations would be needed to offset the effect of a weak currency on inflation,

Forbes co-authored the paper with two BoE researchers, Lewis Kirkham and Konstantinos Theodoridis.

Reporting by David Milliken, editing by Andy Bruce/Jeremy Gaunt

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