A changing reaction function?
A subtle shift in policy may be taking place inside the Bank of England
ROUGHLY SPEAKING, there are two reasons the future central bank policy path might evolve. The first is due to changing data given the policy reaction function in place. The second is due to a change in reaction function for given data. With this in mind, there have been important signs in recent weeks that the Bank of England might be rethinking how to react to incoming data from here—a changing reaction function, shifting emphasis from automatically hiking in response to sticky incoming inflation data back towards setting policy in a forward-looking way based on inflation projections.
Put another way, the Bank might be becoming proactive in their policy narrative instead of being entirely reactive to data. This is how inflation targeting was supposed to be!
This subtle, but welcome, shift can be detected in Chief Economist Huw Pill’s recent speech at the South Africa Reserve Bank. But still, not all is comfortable in this emerging narrative.