The Bank of England is studiously non-party political. But with the UK economy – and the cost of living – centre stage in an election campaign that is steadily ramping up, the central bank’s quarterly inflation report on Thursday will be more closely scrutinised than usual.
Here are the key elements to watch out for:
1. First deflation report?
Since the BoE began publishing its quarterly inflation report in 1993 it has never produced a central forecast that showed negative inflation.
It is a racing certainty that the BoE will revise its near-term inflation forecasts lower. At the time of the last inflation report in November, it was expecting oil to average $89.25 a barrel this year. Oil has bounced back a little over the past week, but is still trading substantially below that level at around $57.
Given that in January the BoE saw a roughly even chance of outright deflation in the first half of 2015, and utility prices have fallen since then, Simon Wells, a former BoE staffer who is now chief UK economist at HSBC, said it was “quite likely” there could be a forecast for “mild deflation”.
But while much of the commentary to date has been around the impact of low oil prices will have on the UK economy this year, the consequences for the medium term are less certain.
Alan Clarke, economist at Scotiabank, said it was “much harder to call than usual” whether the BoE will alter its medium-term inflation forecast, adding that the central bank could keep its medium term projection unchanged or even higher “if it believes that the boost from lower energy prices is sufficient to push growth and core inflation higher.”
2. Letter to the chancellor
While the BoE has said it believes the slide in oil will boost growth and disposable incomes, there is the risk that if deflation persists it would damp inflation expectations and cause consumers and businesses to delay purchases in the expectation prices will fall further.
The UK’s headline rate of inflation fell to 0.5 per cent in December, triggering a letter from Bank of England Governor Mark Carney to Chancellor George Osborne explaining why inflation has moved so far from the 2 per cent target, and what if anything the BoE intends to do about it.
This letter – likely to be only the first in a series – will be published alongside the inflation report and will provide further colour from the BoE on its thinking.
3. A nudge to market expectations?
Since November, markets have continued to push out their expectations for the first interest rate rise. While volatile, these have been suggesting the first rise will be mid to late 2016. Mr Carney has previously used speeches and interviews to try to nudge the market when he thinks it is has gone too far in one direction – will he do so this time? And if so, will traders listen?
David Tinsley, economist at UBS, said he thought that the rate-setting monetary policy committee would be a “little uncomfortable” with the extent to which expectations have slipped, but added “given the renewed concerns over Greece and the eurozone, this is probably not the week to come out with guns blazing in a hawkish direction.”
But Mr Wells said the MPC “may wish to fire a warning shot that interest rates are not a one-way bet.”
Why does it matter? Well, if traders become too confident that rates will stay on hold, they may shift their focus to more risky investments in search of returns and potentially store up problems for the BoE’s financial stability arm.
4. The fundamentals
It was only a short time ago that the strength of the UK’s economic growth, coupled with falling unemployment and the first signs of rising wages, meant that rates were expected to start rising this summer.
The question for the BoE is how far they will ignore any period of low inflation. After all, they injected huge sums of money into the economy in the form of quantitative easing at time when inflation was running well above target.
Wages are again likely to be one of the main triggers. But it is worth noting that the inflation report represents the “best collective judgement” of the MPC, and individual members will always have different views, or not agree with some of the assumptions in the report.
Bank watchers always try to gauge the extent of the range of views among the committee as a clue to the areas that could lead to dissenting votes on interest rates.
With the two MPC members – Martin Weale and Ian McCafferty – who had been previously voting for a rate rise changing their mind in January, analysts will focused on what could make them – or other members of the committee – again start voting for increases.
Copyright The Financial Times Limited . All rights reserved. Please don't copy articles from FT.com and redistribute by email or post to the web.