Sentance: Bank of England is wrong about UK's economy

MPC hawk says credibility may already have been lost by failure to curb inflation
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The Independent Online

A senior Bank of England policymaker has warned that the Bank will "take many years" to get inflation back to the official 2 per cent target, and that the "credibility and commitment" of the Bank's Monetary Policy Committee (MPC) "may already have been eroded" by not raising rates sooner. Inflation stands at 4 per cent and the Bank predicts it will fall to 2 per cent in 2012.

Andrew Sentance, an external member of the committee whose termexpires with the next MPC decision on 5 May, warned in an outspoken valedictory speech yesterday that his disagreements with other elements on the MPC, which voted to leave rates on hold again last month, were about more than just "timing".

Dr Sentance has argued recently for a 0.5 percentage-point rise in rates, and now questions whether the way the Bank views the economy is even correct. The Bank has long placed prime importance on the so-called "output gap", a measure of how far the economy is operating below supply constraints. This, said Dr Sentance, was now damaging both the Bank and the economy.

"The view that spare capacity and the weakness of demand would push down on prices and costs underpinned forecasts that inflation would fall sharply in the wake of the recession," he said. "That has not happened in a world where other powerful influences on inflation – from the international economy, the value of the pound and the general pricing climate – haveoperated in a much more inflationary direction."

The depreciation of sterling – down by about 25 per cent on its 2007 peaks – has gone too far, suggested Dr Sentence, especially now that the manufacturing sector is so small that it is reaching the limits of its capacity to generate growth without "investment in skills and capacity".

The Bank's Agents Survey last week also bemoaned the lack of UK substitutes for imports. And Dr Sentance's critique was given support in the latest CBI survey of industrial trends, which reveals more companies struggling to contain the global commodity price boom and having to pass price rises on to customers here and abroad.

The balance of manufacturers expecting to raise their domestic prices over the next three months climbed to a 12-year high of 36 per cent in April, from 33 per cent in March – a 30 percentage-point jump on October, and the highest since 1990. For exporters, this trend also threatens to whittle way the competitive advantage from the exchange rate.

The CBI also reported a slowdown in the pace of the manufacturing revival. Lai Wah Co, the CBI's head of economic analysis, said: "Perceptions of order book levels have dipped in the monthly data, but the readings are still well above the long-run average. Growth remains robust".

Today's release by the Office for National Statistics of a preliminary estimate for GDP growth in the first three months of the year has been eagerly awaited, and Dr Sentance dropped a hint that he expected the number to be weak, but also misleading.

"I would caution against putting too much weight on the initial estimate of GDP growth for the first quarter of this year," he said. "Such early estimates of GDP need to be interpreted alongside other evidence we already have about the performance of the economy."

Analysts are divided in their forecasts for today, ranging from 0.2 per cent to 0.8 per cent. The fourth-quarter data for 2010 showed a contraction of 0.5 per cent, largely caused by the snow and the ONS said that, without that, output would have been "broadly flat". So a figure of 0.5 per cent, say, would show the economy had made no ground in the past six months, underlining Labour's case that the Coalition has been cutting "too deep and too fast".

Meanwhile, Dr Sentance may follow ex-MPC member David Blanchflower, in becoming an increasingly harsh critic of the Bank. For now, as one City wag put it, Dr Sentance does seem not ready to come to a full stop.