Following its latest gathering, the Shadow Monetary Policy Committee (SMPC) voted by six votes to three to raise Bank Rate to 1% when the official rate setters next meet on 10th March. All three dissenting SMPC members wanted to hold Bank Rate at its present ½%. The SMPC members advocating a ½% increase in Bank Rate did so for three main reasons. A repeatedly mentioned one was the threat to the credibility of the UK’s counter-inflation framework if the Bank went on ignoring persistent overshoots of the inflation target. The concern was that it would eventually require a more aggressive and disruptive monetary tightening if credibility was lost than if Bank Rate went up immediately. Three SMPC members also questioned the Bank’s reliance on a closed economy ‘output-gap’ model of inflation rather than an open-economy model in which sterling had a major role to play in determining the price level and was a crucial transmission mechanism through which monetary policy affected the economy. The third concern amongst the SMPC hawks was that accelerating inflation was covertly and inappropriately reducing the real rate of interest, and that this could itself lead to a self-feeding upwards spiral in the rate of price increase.
One explanation of why other SMPC members thought that it was better to hold Bank Rate was the apparent weakness of UK activity in late 2010. Nobody doubted that the negative fourth-quarter growth figure was distorted by December’s severe winter weather. However, the doves believed that there had been either a ‘growth pause’ or a small fa