The Bank of England, or BoE, is facing criticism from the Lords Economic Affairs Committee for its inaccurate inflation forecasts and lack of intellectual diversity, which may have contributed to the U.K.'s current high inflation rates.
In a recent report, the committee said that the institution had made "errors" in its response to the inflationary pressures stemming from the COVID-19 pandemic and Russia's invasion of Ukraine.
Although these global events were impossible to predict, the sustained high inflation, which reached 11.1 percent last year – the level in 41 years – was also a consequence of monetary policy errors.
The BoE initiated its first interest rate hikes in December 2021, when inflation exceeded five percent. Since then, the bank has successfully implemented 14 consecutive interest rate hikes, leading to a decline in inflation to 4.6 percent. However, inflation remains double the bank's target of two percent, necessitating further monetary policy adjustments.
Despite becoming the first Western central bank to raise rates, the bank's initial efforts to curb inflation were hampered by persistent supply chain issues and the withdrawal of COVID-era economic support measures, such as the furlough scheme.
The committee also expressed concerns about the BoE's expanding responsibilities, which cover areas such as climate change and energy security. These might be detracting the bank from its primary obligations of maintaining financial stability and controlling inflation. To regain focus, the bank should prioritize its primary objectives and "prune" its responsibilities.
The Lords Committee declared the public is losing confidence in the bank due to this prolonged issue. Lord George Bridges, the chair of the committee, in particular, stressed the need to draw lessons from these missteps to rebuild trust.
"Looking at the most recent period it's important to stress in our mind that all central banks have made errors in the handling of inflation and seeing it as transitory; the Bank of England was not alone," said Bridges. "While it is true that the Bank wasn't alone, that doesn't mean to say there aren't lessons to learn."
The report also suggested increased parliamentary scrutiny of its decisions while also maintaining the bank's independence. It recommended conducting a performance review every five years, especially on its remit, performance and operations.
In response to the report, a spokesperson for the BoE said, "We'd like to thank the Lords [economic affairs committee] for this report and will be giving the recommendations careful consideration. We'll respond formally in due course."
Seeking external assistance
The BoE has initiated its internal review to identify the root causes of these missteps. In July, it sought to diversify its intellectual capital by enlisting the expertise of former U.S. Federal Reserve Chair Ben Bernanke to spearhead a comprehensive overhaul of its forecasting models. The findings of this review are expected to be released in the spring of 2024.
In September, Bernanke unveiled that the review of the new forecasting models would be "forward-looking" instead of a "review of policy decisions" but draw upon the experiences of other central banks. The review is anticipated to adopt an approach similar to that of the U.S. Federal Reserve.
According to the BoE's terms of reference for the review, it is prepared to modify its approach to providing guidance on interest rates. One of the questions Bernanke would examine is "the appropriate conditioning assumptions in projections, including the interest rate path on which the forecast is based."
The bank also intends to examine "the respective roles of the MPC and the staff in formulating the official forecast" as part of the review. Currently, the forecasts released in the MPC's quarterly report on the U.K.'s economic outlook stem from staff analysis but reflect the MPC's collective judgment.