In her first speech as Deputy Governor for Monetary Policy at the Bank of England (BoE), Clare Lombardelli stated there are risks that UK inflation will be more persistent than expected. She noted that:
… there’s a risk that demand remains strong relative to supply so that inflationary pressures remain. A tight labour market would give workers more power in wage setting and resilient demand would enable firms to raise prices by more than would be consistent with inflation at target sustainably.1
These concerns about inflation and wages are shared by central bankers in other economies. This reflects a common pattern of headline inflation having declined sharply from its post-Covid peak, but services inflation and wage growth both remaining uncomfortably high.
Recently, the BoE has started to think of policy in terms of scenarios. The Bank’s Monetary Policy Summary for November 2024 spells out three scenarios:
- Scenario 1 assumes that wage growth and inflation decline following the unwinding of the global shocks that drove up inflation. If the economy evolves in this way, monetary policy can be relaxed quickly.
- Scenario 2 assumes that some economic slack is necessary for this process to be completed. Monetary policy then needs to be tighter for a little longer to ensure that inflation returns to target. This is the Bank’s main scenario.
- Scenario 3 assumes that inflation persistence reflects deeper structural changes in wage and price-setting that require a longer period of restrictive monetary policy to prevent inflation expectations from drifting upward.
The chart below shows UK services inflation and wage growth, which the MPC views as good indicators of underlying price pressures.