Bank of England Governor Andrew Bailey said the bank should not over-react to temporarily high inflation in order to safeguard the recovery.
At the Mansion House speech on Thursday, Bailey said the rise in inflation is set to be a temporary feature of the bounce-back. A premature tightening of policy to contain inflation will undermine the economic recovery, he noted.
However, the bank will continue to watch the outlook for inflation and in case of signs of more persistent inflation pressure, the bank is prepared to respond with the tools of monetary policy, the governor said.
At the monetary policy meeting last week, the bank forecast inflation to exceed 3 percent temporarily, and to fall back once the impact of rising commodity prices prove transitory.
The governor said there are at least three reasons why the increase in inflation should be temporary. First, there are annual inflation base effects caused by very weak activity and prices last year which will not last beyond a year as a matter of arithmetic.
Second, additional price pressures can arise from the various shortages caused by imbalances in the recovery of supply and demand, as the latter recovers more rapidly than the former. But these imbalances should not last.
Third, the bank expects to see switch from demand for goods towards services as restrictions are lifted, which should rebalance the composition of demand. Over time, this should lead to an easing of inflation as spending is redirected towards sectors with more spare capacity.
Bailey said the economy will revert to the lower average underlying growth rates. “Reverting to the pre-Covid pattern of lower trend growth will bring its own challenges,” Bailey observed.
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