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Voting record

Inflation has come down sharply in the past few months. In the main this reflects the reversal of the direct impact of the huge jumps in import prices caused first by the pandemic and then the war. But their secondround effects on domestic wages and prices continue to be felt. Although these too have begun to turn, the MPC believes that monetary policy should remain restrictive for the time being. Any reduction in Bank Rate would require further evidence that these more persistent, domestic components of inflation are sustainably on their way down.

I’ll first say a bit more about the behaviour of import prices over the past few years. I’ll then describe briefly the origins and importance of these second-round effects, seeking to explain why, over the past year or so, the Committee has paid particular attention to the behaviour of wage growth and services inflation. I will go through my voting record in this context.

Though their origins were obviously very different, the pandemic and the invasion of Ukraine – more particularly Russia’s decision to reduce its supply of energy to western Europe – had similar economic effects. They both led to substantial increases in the cost of the UK’s imports, boosting directly the equivalent components of the CPI and reducing real incomes.

In the case of the pandemic these increases arose from the combined effects of a big shift in consumer demand around the world, away from services and towards (core) goods and, at the same time, a reduction in the supply of those goods, from East Asia in particular. In the case of the war, Russia’s decision to reduce its supply of gas to western Europe and to inhibit exports of grain and fertilizer from Ukraine, led to significant rises in the wholesale prices of energy and food.

It’s important to understand quite how large these increases were. Through much of the inflation targeting period the cost of imported goods tended to fall rather than rise. (During the decade leading up to the financial crisis, for example, the average price of goods imports fell by 8%.) By contrast, between the spring of 2021 and the autumn of the following year – so in the space of only eighteen months – they rose by 40%.

This had marked direct effects on retail goods prices. Including those of energy and food, the average price of goods in the CPI rose by around a quarter in the two years to March 2023. Depending a bit on precisely how one defines it, this direct effect was responsible for close to nine tenths of the average overshoot of aggregate CPI inflation, relative to the 2% target, over that period.

More significantly, as far as the persistence of inflation is concerned, these jumps in import prices reduced the UK’s real national income. Relative to the price of domestic output, aggregate import prices (including those of services) rose by close to 20% over that 18-month period. Because imports account for around 30% of UK demand, this reduced real national income by around 6%.

Some of this was absorbed by higher government borrowing (used partly to fund cost-of-living payments). But the remaining hit to private-sector income was an inevitable consequence of the reduction in the supplies of tradable goods (and, in the case of core goods, a pandemic-related rise in the global demand for them). One way or other – whether through falls in the first, declines in the second or some combination of the two – there was bound to be a fall during this episode in domestic prices and wages relative to the price of UK’s consumption.

It is this hit to real incomes that precipitated a reaction in domestic wages and prices; and it’s these secondround effects to which monetary policy has been responding.

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