Why core inflation is such a problem for MPC rate-setters

Catherine Mann, the Bank of England’s hawk-in-chief, has been showing her talons again – this time across the Atlantic at a meeting of the National Association for Business Economics, where she is a fellow. “Gas prices in particular are on the downslope, and that type of dynamic is going to be very important in driving headline inflation down,” said Mann, an external member of the rate-setting Monetary Policy Committee (MPC).

However, she issued a warning: “Core goods and services are trending up … it is going to make it very difficult to do our job.” Indeed so. The Bank of England’s 2 per cent inflation target is based on the Consumer Prices Index (CPI), the most commonly used measure of inflation. The downward trajectory of gas and energy prices will have a big downward impact on that number in the months to come.

CPI compares a basket of last year’s prices to this year’s for each month of the year. We’re fast approaching the time when this year’s energy prices will be compared with 2022 when they were at their peak; as they have started falling, inflation will thus inevitably fall. It would fall even if prices remained flat because last year’s surge in prices will no longer be a part of the calculation; this is what economists refer to as “base effects”.

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