In May 2009, the Bank forecast that CPI inflation, then 2.9pc, would fall to 0.7pc during the second quarter of 2010. The outturn was 3.5pc. One astonishing forecasting error could be seen as unfortunate. Two in a row and even reasonable people might think the Bank is wilfully ignoring future price pressures.
That?s where we?re heading. In August 2010, the Bank said CPI inflation would fall to 2.8pc in the second quarter of 2011, reaching 2.2pc by the end of this year. This coming Tuesday, we may learn that inflation in January topped 4pc. Based on recent trends, a 5pc CPI number in the coming months isn?t unlikely.
The Bank won?t be able to blame the high January number on last month?s VAT rise, seeing as the impact of that was already part of its August 2010 forecast. It will likely point, instead, to high oil prices.
But it has long been obvious that commodity markets would stay firm in the face of rising demand from the Eastern emerging giants. At the very least, such an outcome was a genuine possibility.
The Bank?s claim that above-target inflation is ?temporary? has been blown out of the water. As a result, UK monetary policy has a serious credibility problem. That matters ? a lot. For several years now, the Monetary Policy Committee has collectively argued that economic weakness pointed to an absence of inflationary pressures.
This view, while comforting for the UK?s hugely indebted government, was spectacularly wrong. So unless the Bank takes steps to rebuild its credibility, expectations of future inflation will be self-fulfilling.
Yet still the Bank and its courtiers maintain their position ?without a shadow of doubt?, turning their faces against the torrent of evidence which makes a nonsense of their view. Last month, the respected CIPS producer input price index hit 84.9 ? a record high. Meanwhile, producer output inflation soared to 4.8pc, highlighting serious future price pressures.
Producers are facing higher costs but the inexorable fact ? as anyone who does their own shopping will tell you ? is that such costs are being absorbed by wholesalers and consumers. This has been clear for some time now and very strongly suggests medium-term inflation won?t slow nearly as much as the Bank insists.
The CPI is, anyway, a deeply flawed index. The Bank used to target the more accurate RPIX ? before Gordon Brown, in yet another example of his statistical dishonesty, moved the goalposts in 2003. RPIX inflation is now 4.8pc ? almost double its previous 2.5pc target, having averaged that level for over a year.
With the CPI stubbornly above target, the inflation-deniers have tried focusing attention on so-called ?core? inflation ? a measure excluding food and fuel. This may be useful in a country where no-one drives or eats. In Britain, it amounts to nothing more than ?statistical spin?.
Even the UK?s core inflation index is now flashing red, reaching 2.9pc in December, a six-month high. So if you ignore the recent commodity price spike, CPI inflation was still way above target at the end of last year. That was at a time when, as we recently learnt, the UK economy was contracting. Despite these stark realities, the majority of MPC members, paid by the public purse, are still telling us that inflation isn?t a problem.
With ?core? measures giving awkward readings, the deniers have lately reached for an even more obscure inflation index ? CPIY. That registered 2pc in December, but excludes indirect taxes. Given that, CPIY hugely understates genuine inflation as it assumes such taxes are fully passed-on to consumers. The Government?s own research indicates actual tax pass-on is much lower and, had tax rates remained stable, inflation would still be around 3pc.
Perhaps the most disturbing aspect of the MPC?s analytical failure has been its reliance on the so-called ?output gap?.
Under this mode of thinking, we are invited to believe the UK can massively expand the base money supply, and the Government can keep borrowing like crazy, with no fear of inflation whatsoever ? because the UK?s enormous ?spare capacity? can soak up extra demand without driving up prices.
For several years, now, this column has referred to the output gap as an ?intellectual conceit?. Given the ferocity of the credit crunch, the UK has lost enormous productive capacity, as firms have closed, workforces have dispersed and some companies, in a desperate bid to survive, have been forced to flog their capital goods to overseas buyers. And while unemployment in the UK is quite high, a large rump of our jobless are, given their lack of skills, sadly unemployable.
The inflation numbers we?ve been seeing mean that much of the economics profession is now starting to agree with this view.
Even within the Bank itself, Dr Andrew Sentance, who until recently has stood bravely alone on the MPC in calling for a rate rise, dubs output gap analysis a ?narrow way of thinking?.
Last week Professor Tim Besley, a former MPC member, said he was also ?very sympathetic to the view there has been a very big supply shock? in the UK.
The reality is that for all the policy elite?s pomposity and statistical hocus-pocus, investors have become worried about UK inflation.
Having believed at the start of 2011 that there was little chance of a rate rise this year, the markets are now betting heavily that the Bank will simply have to act by May.
Tolstoy?s words above come from The Kingdom of God is Within You ? his non-fiction magnum opus. This is an exploration of truth, not least within the realms of public policy. As such, Tolstoy?s quotation offers us an early explanation of so-called ?confirmation bias?, the tendency of powerful people to favour evidence that backs up the version of events they need to be true, even when such evidence ultimately disproves their views.
Advocates of a UK rate rise aren?t ?inflation nutters?. We believe, instead, that action is required now, before the markets force the issue, to prevent higher inflationary expectations worsening Britain?s output-inflation trade-off, thereby seriously harming future growth. As it happens, common sense and decades of policy evidence are on our side. But that won?t stop legions of otherwise intelligent and prominent people from dismissing us as ?mad?.
? Liam Halligan is chief economist at Prosperity Capital Management
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