A senior Bank of England official has raised the prospect of interest rates rising sooner than expected if economists are proved wrong about the power of a strong pound to hold down inflation.
Kristin Forbes, one of the nine rate-setting members of the Bank’s monetary policy committee, questioned whether current economic models were accurately reflecting the relationship, or “pass-through”, between exchange rates and the outlook for inflation. That, in turn, had important implications for monetary policy, she said in a speech.
“This limited understanding of how exchange rate movements affect inflation is – to be candid – quite frustrating for those of us tasked to set monetary policy. This is a crucial relationship – especially for an open economy such as the UK,” Forbes told the Money Macroeconomics and Finance research group conference in Cardiff.
The stronger pound has cut the price of UK imports and is seen as a key factor in keeping inflation hovering around zero in recent months. With inflation well below the Bank’s government-set target of 2%, financial markets are not expecting interest rates to rise until next year
