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Does the Bank of England need to revise its 2% inflation target?

Journalist: John Choong (Head of Markets and Research), Newspage

ended 15. July 2024

An analysis of Bank of England data by Newspage has found that the Bank of England has only managed to keep inflation at the 2% (more specifically, between 1% and 2%) target 30% of the time since it gained independence in 1997.

The graph above shows the record the Bank of the Bank of England over the past 27 years, with inflation running above and below target most of the time. Of course, some of these instances were down to factors outside their control, such as the Global Financial Crisis (GFC), but it also begs the question of whether it should adopt a more flexible inflation target as a result.

While 1-2% is widely seen as the ideal range in order to maintain price stability, sticking to such a textbook figure may be a fool's game given how susceptible the UK's economic growth has been to geopolitical affairs. After all, there have been several instances where inflation was allowed to run above target in order to spur economic growth, with the Bank even lowering rates in several instances.

Such examples include the 14 months between November 2002 and December 2003, where the Retail Price Index (RPI) ran above the BoE's 2.5% target then. In fact, the Monetary Policy Committee (MPC) opted to even reduce the base rate from 4.0% to 3.5% through the course of this mini inflationary cycle due to fears of potential deflation from the Dot Com bubble bursting a couple of years prior. This strategy was used again during the 2008/09 GFC, when interest rates plummeted from 5.75% to 0.5% while above-trend inflation ran its course from October 2007 to May 2009, as GDP growth was negative for great swaths of this period.

Not only that, the MPC also let inflation run above its 2% target for 4 straight years between December 2009 to November 2013, leaving interest rates at virtually zero — 0.5% in order to support the economic recovery after the GFC. It's also important to keep in mind that services inflation ran as high as 4.9% during this period — still some distance, although not egregiously far from today's figure of 5.7% either. In addition to that, headline inflation ran above target for almost 2 years from February 2017 to December 2018, with policy makers taking 9 months to increase the base rate from 0.25% to 0.75% as they were unsure about the economic impact of Brexit.

This goes to show how susceptible the UK's inflation basket is to geopolitical factors, like energy prices and trading agreements. As such, this opens up a discussion on whether Threadneedle Street should ditch its 2% inflation target and revise it to adopt a more flexible target that takes economic growth into account instead. With this in mind:

  1. Should the Bank of England ditch its 2% inflation target?
  2. If so, how should they approach inflation and balance it with economic growth while maintaining price stability?

5 responses from the Newspage community

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Editor
Justin Moy
Managing Director at EHF Mortgages
There seems to be little correlation between the inflation target and the actions of the Bank of England. Having a generic target of 2% that doesn't evolve with the real-time dynamics of our economy feels outdated. A more flexible approach to the country's finances is necessary, perhaps set by the Chancellor of the Exchequer once a year within the Budget. We seem to be focused on economic theory rather than practice.
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Riz Malik
Independent Financial Adviser at R3 Wealth
The inflation target and the Bank of England need to be dragged into the 21st century peacefully or kicking and screaming. All a 2% target is doing is keeping the Royal Mail in business as the Bank of England needs to write to the Chancellor and tell them why they missed their target. Considering a series of Taylor Swift concerts could railroad a rate cut because of its impact on inflation is ridiculous.
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Michelle Lawson
Director at Lawson Financial
We are a nation that fears change. A target is exactly that and not a necessity. If a stat says you are wrong more than right then something needs to change as it’s clearly not working. Admitting you are wrong and trying something else is something that may be needed: we need that now. Just because it’s the way it’s always been done doesn’t determine the way it always has to be. The Bank of England need to show a maverick approach and cut the base rate on 1st August as consumer confidence is already running low with them.
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Ben Perks
Managing Director at Orchard Financial Advisers
1997 saw the death of Princess Diana, Titanic taking cinemas by storm and the Bank of England gain independence, it feels like a lifetime ago. We need to move with the times. The Bank of England are striving to hit a target that pre-dates the Nokia 3210. It's baffling, especially given the shockingly low success rate.
Our economy is much more robust and diverse than it was in the 90's, we do more business globally which makes us susceptible to events around the world. A 'one size fits all' 2% target is not practical, we need targets that are constantly under review.

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Stephen Perkins
Managing Director at Yellow Brick Mortgages
The notional 2% target was always as irrelevant as the reasoning behind it. With so many factors that influence the overall inflation figures, using it as the main yardstick for determining the Base Rate is inefficient at best. Many times the Bank of England raised the race needlessly trying to fight the wrong type of inflation with the wrong weapon. Sadly taking a bazooka to a knife fight. They should scrap the 2% figure they plucked from the air and make decisions on the needs of the whole economy, starting with a 0.25% reduction on 1st August.