While the timing of the overshoot could scarcely have been worse, it remains the case that the past decade has seen both low and stable inflation.
Indeed, various members of the MPC have expressed surprise that it needed almost 10 years for the Governor of the Bank of England to have to write to the Chancellor to explain why inflation in a particular month had diverged significantly from the target.
When CPI inflation hit 3.1 per cent in March, it was, however, something of a surprise. After CPI inflation reached 3 per cent in December, it then edged down.
After hitting 3.1 per cent in March, inflation has fallen back again to 2.8 per cent in April and forecasters are expecting it to fall further in May and June. To a considerable degree, this reflects the pattern of energy (especially oil) price rises last year compared with this year.
Perhaps the key question is not about inflation in the next few months but about inflation over the next few years. This longer horizon is what the MPC focuses on and, given the range of shocks that could occur over the next couple of years, is more difficult to forecast than over a short period.
One issue for the MPC is whether the per-iod of relatively high inflation – which has been seen more notably in the retail prices index than the consumer prices index – may have raised inflationary expectations. RPI inflation was 4.8 per cent in March, the highest since the early 1990s.
The actions that the MPC has taken in raising rates are aimed at both reducing inflationary pressures and also at influencing inflationary expectations.
The projections for inflation in the Bank of England’s inflation report show that – setting aside the issue of whether interest rates need to rise further or not – inflation is expected to drop sharply in the second half of this year and to be more closely aligned to the 2 per cent target than it has been over the past 18 months.
There are, of course, risks to this central scenario and these are viewed as being greater on the upside.
Considerations such as companies’ ability to pass on price increases, the degree of spare capacity in the economy and the prospects for energy and import prices all come into play. Financial markets are clearly factoring in the likelihood of another rate rise as a result.
For the housing market, the series of rate rises has already had an effect on the prospective number of new buyers.
The surveys by the Royal Institution of Chartered Surveyors have shown five straight months of falling new buyer enquiries. In addition, the number of loans approved for house purchase in the first quarter of the year was 5 per cent down on the final quarter of last year, once usual seasonal variations have been taken into account. While these are signs of slowing activity, they show a gradual process, not a dramatic one.
The gradual raising of rates has, together with the steady rise in house prices, worsened affordability. At the same time, rising inflation will have bitten into the real value of after-tax incomes, adding a further element of squeeze on households. The May rate rise will add to this pressure.
So far, however, the slowing in the growth of new business has not had a really noticeable effect on house price trends. This may, in part, be due to a limited supply of properties coming on to the market, as also indicated by the RICS surveys. But house price increases in recent months have not been as strong as in parts of last year.
Even though annual house price growth remains around 10 per cent, if the pace of buyer interest edges down, so the rate of annual house price growth should slow during the summer and autumn months.
As a consequence, the second half of this year is likely to look rather different from the first half from an economic point of view. For the housing market, there are not many who expect annual house price growth in December to match the 10.8 per cent recor-ded in January.
Base rates are generally expected to be higher than at the start of the year (the year started with base rates at 5 per cent), but inflation should be closer to its 2 per cent target at the end of the year. If this turns out to be correct, the Governor of the Bank of England will be able to put his pen back in its case.