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Carney's letter to Chancellor: inflation will be above target for three years
Bank of England Governor Mark Carney has written to Chancellor Philip Hammond to say inflation will remain elevated for several years and that while UK economic growth is likely to grow faster than he expected this year, Brexit could still throw a major spanner in the works.
After consumer price inflation hit 3.1% in November, the BoE Governor was obliged to explain to the Chancellor the reasons for why the BoE's 2% target was being overshot by more than one percentage point, and what he planned to do about it.
Carney, who was was still obliged to pen the missive even though CPI since retreated to 3.0% in December, said the sustained level of above-target inflation was "almost entirely" due to the effects of higher import prices that resulted from the slump in the pound following the Brexit referendum.
Publishing the letter alongside the quarterly inflation report from the Bank's monetary policy committee that upped forecasts for UK economic growth - assuming a smooth Brexit transition - and an updated statement from the MPC that interest rates may rise sooner than it had indicated, Carney said the committee's central projection was that year-on-year CPI inflation is will "fall back gradually over the forecast, but remain above the 2% target in the second and third years of the MPC's central projection", with the Bank rate increasing to 1.2% in three years' time.
"In the near term, inflation is projected to remain close to recent levels, reflecting higher oil prices. It is possible that inflation could rise temporarily back above 3%. Inflation is then expected to fall back gradually as the effects of the past depreciation of sterling on inflation diminish. While import price increases continue to be passed into retail prices and push inflation up for some time, the extent of that positive contribution is expected to decline."
Carney, who in an interview last month said he could see a "conscious re-coupling" between the UK and the booming world economy but defended his gloomy Brexit predictions, continued to plough his cautious furrow over the potential effects of the UK's withdrawal from the EU, which he told the Chancellor remains "the most significant influence on, and source of uncertainty about, the economic outlook".
He went on: "The overshoot of inflation throughout the forecast predominantly reflects the effects on import prices of the referendum-related fall in sterling. Brexit related uncertainties are weighing on domestic activity, which remains modest even as global growth has risen significantly. And the United Kingdom's withdrawal from the European Union may constrain supply growth, reinforcing the marked slowdown that has been increasingly evident in recent years in the rate at which the economy can grow without generating inflationary pressures."
He stressed that there was only so much the MPC can do, suggesting the slow return to 'normal' monetary policy was very much led by the clouds on the horizon cause by Brexit.
"Monetary policy cannot prevent either the necessary real adjustment as the UK moves towards its new international trading arrangements or the weaker real income growth that is likely to accompany that adjustment over the next few years. But it can influence how this hit to incomes is distributed between job losses and price rises. And it can support UK households and businesses as they adjust to such profound change."