How Bank of England Predicts Inflation

To predict inflation the MPC looks at statistics such as

Present inflation data
Commodity prices especially oil
Manufacturing output prices
Nominal wages increase
House Prices
Levels of Mortgage borrowing
Number of Home repossessions
Stock Markets
Consumer spending and consumer confidence, the level of consumer borrowing is also important
Exchange Rates
Import Prices (20% of RPIX is generated by import prices
Inflation expectations
% of firms working at full capacity, this is difficult to precisely predict and is usually done by surveys
Money Supply e.g. M0 M4
Economic Growth and compared to the Long run trend growth rate.
The MPC may also look at key issues such as the Asian debt restructuring crisis.

These variables may vary in importance e.g. at the moment 2002 the housing market is a key factor in keeping interest rates high.

Often variables will give conflicting information e.g. the house prices increased 24% in 2002, but Manufacturing sector was in a recession

With this data the MPC generate models of the most likely path of CPI inflation over the next 2 years. These projections are produced in the form of fan charts The inflation rate can never be accurately be predicted but probabilities can be introduced

If the committee believes CPI will increase above the target due to long term factors (tax increase would only affect inflation in the short term) Then they will increase interest rates
The MPC meets every month to decide on the interest rate