BOE Broadbent Says Central Bank Will Watch For Bad Deflation Signs

Consumer price inflation fell to zero in February, and is expected to fall further below in the first half of this year. But the possibility of a prolonged period of downward spiraling prices is very low in the UK, BoE Deputy Governor Ben Broadbent said today.

In a speech given today at the Imperial College Business School in London, Broadbent said that the UK is currently experiencing “good” deflation, which he said is deflation that has “been caused by something (a drop in oil prices) that improves real incomes.”

But he also said that inflation will remain below target [2%] for the next twelve months, and that “the MPC [Monetary Policy Committee] will obviously have to be watchful, in the meantime, for signs that ‘good’ deflation is turning into something worse.”

Broadbent reiterated that much of the downward pressure on inflation comes from external sources such as cheaper commodities. In other words, Broadbent argues, disinflationary forces in the UK have been driven “not by the declining value of what we sell, including wages – though weak by pre-crisis standards – but by a steep fall in the real price of something we buy [such as crude oil].”

Broadbent further said that persistent deflation is very rare, or even unique, in economies with credible and independent monetary policy, and floating currency exchange rates.

“There’s a general tendency for changes in inflation to be more persistent when the exchange rate is fixed. At least when policy has a degree of credibility, deviations of inflation tend to peter out relatively rapidly in countries with independent monetary policies,” Broadbent said.

But he also reiterated that very low inflation today may suppress wage growth this year: “Even though the direct effect of that decline will drop out of the annual comparison later this year and in early 2016, there’s a risk that, by depressing wage growth, sub-target inflation could persist for longer than we expect.”

Broadbent also dismissed that deflationary expectations necessarily translate into people postponing spending, saying such a presupposition is only partly true, or “at worst a bit misleading.” He argued that it is more about “the extent to which expected inflation lies below the nominal rate of interest, i.e. the real interest rate [rate of interest minus inflation],” rather than inflation expectations on their own.

via WBP Online

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