Managing the present,
shaping the future - speech
by Clare Lombardelli
Given at the Bank of England Watchers Conference, London
Published on 25 November 2024
In her first speech as Deputy Governor for Monetary Policy, Clare Lombardelli sets
out her views on the UK economy and the risks to the outlook. She then presents
the Bank's plan to implement the Bernanke Review.
Speech
Good morning. Thank you for inviting me. It's a pleasure to speak at the Bank of England
Watchers Conference, in front of many of our key stakeholders. This is my first speech as Deputy
Governor for Monetary Policy. So I'll start by setting out my view on the economy and the outlook -
how I am "managing the present". I'll then move on to talk about the Monetary Policy
Transformation Programme we are undertaking in response to Dr Bernanke's review - how we
are "shaping the future". This is a big reform programme. We are going to handle uncertainty
differently, putting different scenarios - different stories about the economy - closer to the heart of
policymaking and communications. To do that, we are making a major investment in our tools, our
processes and our people. We have made some progress since the review was published in
April, but have a long way to go. We want to engage with you on this journey. I will come back to
the details shortly.
The evolution of the UK economy
Inflation has fallen steeply over the past two years, from its peak of 11.1% in October 2022 to
2.3% in October 2024. This mainly reflects the ongoing unwind of the very large external cost
shocks that hit the UK in 2021 and 2022 and that made UK inflation rise steeply in the first place.
As you can see in Chart 1, the key driver of the increase in inflation was the rise in goods prices.
This was a result of the global supply constraints that arose during the pandemic, and the large
rise in energy and then food prices associated with the Russian invasion of Ukraine. In turn, higher
energy prices pushed up goods prices further.
Chart 1: External shocks have driven the large rise and then fall in UK inflation
Sources: ONS, Department for Energy Security and Net Zero and Bank calculations. Chart shows the MPC's latest near-
term inflation forecast, consistent with the November MPR. It does not reflect the October CPI data released on 20
November, which was broadly in line with this forecast. Figures in parentheses are CPI basket weights in 2024. The food
component is defined as food and non-alcoholic beverages.
The MPC monitors closely a range of measures of underlying inflation. We take a
forward-looking approach given the lags in monetary policy. A simple and observable proxy
measure is services inflation, as services prices are mainly affected by domestic and
slowermoving factors. Even though headline inflation fell steeply from its peak and has been around
target for half a year, services inflation is still above its pre-pandemic average (Chart 2) - it was
5% in October and we expect it to stay around that rate for another few months. As a result, as the
tailwind from lower energy prices dissipates, we expect headline inflation to rise back to 2.8% in
the third quarter of 2025.
Chart 2: Services inflation still above its pre-pandemic average
Sources: ONS and Bank calculations. Chart shows the MPC's latest near-term inflation forecast, consistent with the
November MPR. It does not reflect the October CPI data released on 20 November, which was broadly in line with this
forecast. Core goods = goods excluding food and non-alcoholic beverages, alcohol, tobacco and energy. Dashed lines
represent 2010-19 averages which are 3.0% and 0.8% for services and core goods respectively.
Wages are a material driver of services prices, and the slower-moving nature of services inflation
reflects in large part the relatively high 'stickiness' of wages compared with other prices. This is
clear in Chart 3, which shows a model-based decomposition of a "core" measure of services
inflation.[1] This model specifies core services inflation in terms of pay growth and manufacturing
producer output inflation; the latter captures the cost of goods used to produce services, including
energy. The model suggests that most of services inflation is driven by what's happening to pay
growth.[2]
Chart 3: Wage growth is a material driver of services inflation
Sources: ONS and Bank calculations. Core services inflation excluding rents. Final data point is 2024 Q3. The model is
estimated on seasonally adjusted quarterly data excluding VAT. Estimated contributions to services inflation are based on
autoregressive distributed lag regressions of services inflation on pay growth (orange bars) and manufacturing PPI inflation
(aqua bars). See also Greene (2024) and Mann (2024).
In principle, higher-than-usual profit margins could also be driving the current elevated services
inflation. But we regularly monitor developments in companies' margins and there is little evidence
of that. ONS data show that the profit share of aggregate income has fallen slightly in recent years;
and the Bank's Agents and company surveys suggest that profit margins, including in the services
sector, fell or were flat in 2022 and 2023 and are likely to remain compressed in coming
quarters.[3]
So we are paying close attention to wage developments. Chart 4 shows a decomposition of wage
growth used by Bank staff to inform the MPC projections. Wage growth is decomposed into short-
term inflation expectations, a measure of labour market tightness and productivity growth. This
model suggests that wage growth since 2021 can be explained mainly by changes in short-term
inflation expectations and labour market tightness.[4]
Chart 4: Wage growth has fallen back but is still above pre-pandemic rates
Sources: Barclays, Citigroup, ONS, YouGov and Bank calculations. Final data point is 2024 Q2. Wage equation based on
Yellen (2017). Pay growth is Bank staff's estimate of underlying pay growth between January 2020 and March 2022 and the
ONS measure of private sector regular AWE growth otherwise. Short-term inflation expectations are based on the Barclays
Basix Index and the YouGov/Citigroup one year ahead measure of household inflation expectations and projected forward
based on a Bayesian VAR estimation. Slack is based on the MPC's estimates, informed by the vacancies to unemployment
ratio. Productivity growth is based on long-run market sector productivity growth per head.
The chart shows that wage growth has already fallen materially from its peak of 8.1% in mid-2023
to 4.8% in the three months to September, but is still above its pre-pandemic rate. I take two other
points from this chart. First, it suggests that the labour market is still a little tight and continues to
exert upward pressure on wages, although this effect has been easing gradually. That's consistent
with the signal from a range of labour market indicators; for example the
vacancies-tounemployment ratio has fallen back to its 2019 level, but that was somewhat tighter than in the
past. The information we are receiving from our agents is also consistent with the picture of an
easing but still relatively tight labour market. Second, this model cannot fully explain the current
strength of wage growth, as shown by the residual. This excess persistence in wage growth is
probably associated with continuing second-round effects of the past inflationary shocks.[5] The
way the persistence in wage and price inflation evolves from here is uncertain and to help
consider this, the MPC set out three "cases" for the economy in November. I'll come back to these.
There are some signs that the process of wage disinflation may be slowing. Chart 5 shows
companies' expectations of wage growth from the Bank's Decision Maker Panel (DMP) survey.
Firms expect wage growth to decline further, but their one-year ahead expectations seem to have
stabilised in recent months. Last month our Agents reported that contacts expected pay awards in
2025 to moderate to around 2%-4%. We'll need further intel to assess where in that range we're
likely to land. If we use the decomposition from Chart 4, assuming productivity growth of c.1% and
a labour market broadly in balance, wage growth would need to be around 3% to be consistent
with inflation at target.
Chart 5: The DMP survey suggests wage disinflation may be slowing
Sources: DMP Survey and Bank calculations. Final data point for realised wage growth is October 2024. Diamonds show
expectations for wage growth one year ahead.
More broadly there is large uncertainty around the labour market and wage developments. The
labour market is subject to both structural and cyclical changes. And we are hampered by the
challenges of the quality of data, in particular in the Labour Force Survey. There have also been
recent changes to the costs of employment from the combination of the increase to the National
Living Wage, the rise in employer National Insurance Contributions and potentially the changes to
workers' rights. Although the size, timing and interaction of these effects are uncertain.
Risks to the economic outlook
In September the MPC set out three "cases" for how the economy could evolve from here (Chart
6). In Case 1, disinflation is driven by the unwind of the external shocks and that will continue to
feed through to pay and price setting. Just as inflation rose on the back of external shocks, even
its more persistent components will revert to target as those shocks recede. If the economy
evolves in this way, monetary policy restriction will need to be reduced more quickly. A large part
of the disinflation process we have seen so far can be characterised in this way. There's been a
lower cost in terms of output lost than many expected a couple of years ago. And disinflation has
progressed faster than expected - one year ago the MPC expected CPI inflation to be 3.3% in the
third quarter of 2024, more than 1 percentage point higher than the outturn.
Chart 6: The MPC set out three "cases" for the UK economy
In Case 2, disinflation is also driven by the unwind of external shocks, but the second-round effects
on inflation are more persistent than in Case 1 and so a restrictive monetary policy stance is
needed for longer for inflation to return to target on a sustainable basis. Our published projection
in the November MPR is based on this case for the economy. In this world, a continuing restrictive
monetary policy stance and tighter fiscal policy are expected to open up a margin of excess
supply, which will support further moderation in wages and prices.
In Case 3, deeper structural changes in the UK economy threaten to impart a more lasting
inflationary dynamic, if not met with a longer-lasting restrictive monetary policy response. Case 3
is articulated on the basis of real income catch-up effects in the November MPR. If this dynamic
persists into next year and perhaps beyond, there is a risk that, absent a policy response, workers
and firms might start to adjust to a new normal of wage increases of perhaps 3.5% or 4% and
price inflation closer to 3% than to the target. That would be more costly to change if it becomes
entrenched.
Each of these cases is broadly consistent with the evidence to date and the economy could evolve
in line with any of them from here. I'll use this framework to talk about how I see the key
uncertainties to the economic outlook, alongside considering broader risks to demand.
Inflation may fall faster than expected, consistent with Case 1. And there is a further risk that the
UK economy proves less resilient than expected to the ongoing monetary restriction and fiscal
consolidation, and / or that there is a possible weakening of the global economy. We have seen
some slowing in other countries in Europe and need to be vigilant to it as the UK shares some
similarities with other European economies. And last week's 'flash' PMIs for November may
suggest some slowing in the UK too, although I don't take a strong signal from a single release.
Given the lags in policy it would be important not to act late if the economy moved in this direction.
Alternatively, there is a risk that inflation is more persistent than expected, as set out in Case 3.
And there's a risk that demand remains strong relative to supply so that inflationary pressures
remain. A tight labour market would give workers more power in wage setting and resilient
demand would enable firms to raise prices by more than would be consistent with inflation at
target sustainably.
I view the probabilities of downside and upside risks to inflation as broadly balanced. But at this
point I am more worried about the possible consequences if the upside materialised, as this could
require a more costly monetary policy response.
The outlook for wages and services prices is unclear from here. We need to see more evidence
that wage growth and services inflation will continue their journey down to
target-consistent rates. But there are some signs that the process of wage disinflation may be
slowing, as shown in Chart 5, so it's too early to declare victory on inflation. It's often been said
that the last mile may be the hardest, and that's where we are now.
This is why I support a gradual removal of monetary policy restriction and will be monitoring the
flow of data over the coming months so we can calibrate our policy path as needed.
Innovations to the MPC policy process in November
As part of developing our response to the Bernanke Review and to help the MPC think more
about uncertainty we started to do things a bit differently over the past few policy rounds, and
made some notable changes in the November round. The aim was to help us think about the
economic channels underpinning the different views across the Committee and consider the
policy consequences and risks if the economy were to evolve in different ways. There were two
main elements to what we did.
First, Bank staff simulated two alternative paths for how the economy may evolve relative to the
baseline under different assumptions about the structure of the economy. The two simulations
captured features of Case 1 and Case 3 respectively, while the published forecast was based on
Case 2.
Using the paths for a range of variables implied by those simulations, we looked at what the
evidence from the current data suggested about how likely they were. We also simulated the
monetary policy response each of them implied, using 'optimal' policy projections.[6] And we
considered the consequences of following the policy path appropriate for one case if in fact it
turned out that a different case applied.
Second, we reconfigured how the Committee spent its time and what the discussions were
focused on. We considered the published forecast alongside the simulations. More Committee
time was dedicated to discussion about the ways in which the outlook for the economy could be
different, how we interpreted the available data, and the implications of that for the path monetary
policy should take.
This was a small step in the broader direction of our response to Dr Bernanke's review, which I'm
going to talk about in more detail shortly. The trialling of some new approaches in November
illustrated areas where we want to develop our tools. The macroeconomic simulations were
constructed using our standard forecasting framework, which isn't designed for the production of
the central forecast and fully-fledged scenarios at the same time. This meant the simulations were
stylised, and that's why they were set out in a qualitative way in the MPR.
But despite those limitations, the analysis provided a helpful starting place for a richer discussion
across the Committee about how the economy may evolve and how to think about different
possibilities and risks in policy decisions.
Transforming monetary policy making
I'll now move on to talk about the comprehensive and substantial reforms we are making in
response to Dr Bernanke's review. We are extremely grateful to Dr Bernanke for his thought and
time. His review provides a thorough assessment of the monetary policy making processes at the
Bank. It is hard hitting; in parts it makes for uncomfortable reading. But we welcome it in its
entirety. It makes 12 specific recommendations for reform, and we have accepted them all.
Let me start by saying what is out of scope before turning to what is in.
The key elements of our institutional framework for monetary policy, set by Government, will be
unchanged. The current framework was set up in the 1990s - the inflation target and the formation
of the independent MPC based around a diversity of views, expertise and experience, supported
by expert analysis from Bank of England staff. This has been fundamental in anchoring inflation
expectations (Carney, 2020).
But within this framework, we are reforming the whole nose to tail process of monetary policy
making and communication. This will be the largest reform since the Bank was granted
operational independence for monetary policy in 1997. We will cover all, but not be limited to, the
areas considered in Dr Bernanke's review. Chart 7 captures the elements of our transformation
programme.
We will change:
Our capabilities, including our data infrastructure and our modelling framework.
The inputs into policymaking, including the role of the forecast and scenarios, and their
underlying assumptions.
The way MPC discussions are structured.
How we use these inputs to inform the MPC's policy decision.
And, how we communicate the policy decision, outlook and risks to both financial markets and
the general public.
We will reform how we organise ourselves, our staffing levels, skills and incentives. And how we
seek and use external input from academics, market participants and other experts.
Chart 7: The elements of our monetary policy transformation programme
The case for reform and the scale of the challenge
In the years following the introduction of inflation targeting in the UK, the economy was largely
subject to shocks that our processes were well set up to manage. But in recent years, the UK has
faced a sequence of supply shocks that led to a sharp rise in inflation. The scale and nature of the
shocks has posed substantial challenges to forecasting not just at the Bank of England but at
other central banks and the economics profession more broadly.
The experience of more frequent and larger supply shocks has also underscored the importance
of communicating uncertainty clearly. And being able to do that in a range of circumstances. Dr
Bernanke's review pointed to the need to think again about how the MPC considers uncertainty
and how it communicates the impact of that uncertainty for monetary policy.
The interactions between the elements of the reform are complex. For example, the
recommendation to use scenarios to better understand and articulate the balance of risks around
the outlook has implications for the design of the forecasting infrastructure, the internal processes
for MPC discussions, as well as for external communications.
The 9-person MPC is made up of a mix of internal Bank executives and independent external
appointees, each with a vote. This builds a welcome and valuable diversity of experience into
policymaking. And is a strength of the UK's monetary policy making system. However, it does
make it difficult to apply an off-the-shelf approach from elsewhere. We will need to think carefully to
ensure these reforms make the most of our unique institutional structure.
I understand that you will all have lots of questions about precisely what the end-state of this
process will look like. These changes will need careful consideration. We are going to take our
time, and we want your help and the help of others to get it right.
The building blocks of our new approach
The forecast and scenarios
Let me start with how we will consider uncertainty. We will widen and rebalance our approach,
placing less focus on a central projection. We will put more systematic analysis around how we
consider risks to, and uncertainty about, the way the economy may evolve. And around how to set
policy considering those risks and uncertainties. We will build the use of scenarios into our
processes. We will loosen the link between the forecast and the policy decision and its
communication. This was one of the overarching recommendations from Dr Bernanke.
This is not entirely new. The MPC has always considered risks and uncertainties. And on some
occasions, the MPC has turned to scenario analysis to improve its understanding of the inflation
outlook.[7]
A wider and more systematic use of scenarios will allow us to better consider alternative
conditioning assumptions and also different relationships between economic variables.
Combined with data analysis it will help us judge the likelihood of different views of the economy,
and to update our judgements on risks and uncertainties over time as the evidence evolves. And it
can help us understand better the consequences of setting policy as if we are in one state of the
world, when in fact we may be in another.
We will consider and publish different scenarios for the economy on an ongoing basis. And we will
look at how monetary policy might need to be different in those alternative outlooks by looking at
policy paths which are endogenous to those scenarios.
Of course, the devil is in the detail of how we design and practically apply these changes. And
there are important questions we will need to work through. These include:
First, what scenarios to choose? We will prioritise policy relevance in our scenario selection
and development, and we expect to be discussing a small number of scenarios at any given
time.
Second, who 'owns' what? We will need to consider the respective roles of the MPC and Bank
staff in the forecast and scenario development. There will be more staff input into the baseline
forecast. This will free up MPC time for discussions of the economy, policy and policy strategy.
We will retain an important role for the Committee in shaping the forecast and in scenario
selection cementing the link between analysis and policymaking.
Third, how to use a broader range of inputs to inform the policy outlook? We will need to
develop our framework for how we will combine the different inputs to best support the MPC's
policy deliberations. How to bring together insights from conjunctural analysis, the baseline
projection, the scenarios, and policy analysis?
Fourth, how to combine these approaches into clear informative communication? Scenario
analysis will help communicate the risks and uncertainty around the economic outlook. And it
will provide an opportunity to increase transparency around our reaction function in different
circumstances. But with many potential paths for key variables there will be a premium on
clearly articulating the outlook and the reasons behind the policy decisions.
One important question is what interest rate path or paths we publish. We will consider whether to
publish the forecast with a modelled endogenous path for policy, either instead of, or alongside, a
forecast conditioned on the market path for interest rates. There are some calls for the MPC to
publish a collective expected interest rate path or to provide a dot plot. As the Bernanke Review
explains, this is a highly consequential issue. This is not as simple as it sounds. Publishing a form
of expected path risks suggesting greater certainty about future rates than it is possible to give,
which in turn undermines policy credibility.
Given the scale of the potential changes, and that we are doing this alongside setting monetary
policy in the coming months and years, we will test and trial our new thinking. The consideration of
cases in the November round I have described was just an initial step, and I expect our approach
will be and look very different in the longer term.
Modelling
We will develop and draw on a wider range of models that capture the different uncertainties that
we want to explore. We use models both to assess the current state of the economy, as well as
forecast its future and to simulate alternative paths and policy responses.
No single model can possibly capture all the relevant features to perform even just one of those
roles adequately. In particular, when there is large uncertainty about the structure of the economy,
we need approaches that can identify the possibility of structural changes and their
consequences. When there are uncertainties about certain economic relationships in the
economy, we need tools and techniques that can focus on those variables.
So we are investing in our modelling toolkit: reviewing, updating and expanding our existing suite
of models. This is a multi-year project and we are still designing our modelling strategy. But we
have already made some progress updating our current core DSGE model COMPASS, as well
as some of the semi-structural and more statistical models that currently support the forecast
process.
We are also developing a large-scale semi-structural model to complement that approach and
help with modelling certain scenarios. We know we will also need to invest in developing a set of
more specialised models to allow us to explore the economics of particular mechanisms in
greater detail, as well as the toolkit that enables us to do a variety of monetary policy simulations
in different scenarios for the economy.[8]
One important question will be how best to synthesise the information from a range of different
modelling approaches for monetary policymakers. And whether we can and should do that in a
more systematic way.[9] This is complex. Some other central banks are, like us, undertaking major
investment in their modelling toolkit and we will be able to learn from them.[10]
Continuous learning
We know that the answers to all these issues won't be found solely in the Bank. And that external
engagement is part of an environment where monetary policy making is supported by a culture of
continuous learning.
We will consult with experts, academics, watchers, market participants[11], and our international
counterparts. We are going to consider the best way to do that effectively. In the meantime, I want
to highlight two initial changes.
There is a lot of expertise outside the Bank on macroeconomic modelling. We want to draw on
that. To start the conversation, we are introducing a new technical paper series, and intend to
begin a series of seminars on those papers in 2025. This will be our primary vehicle for
documenting new models developed in response to the Bernanke Review.
And we will also host a conference in summer 2025 to explore some of the interconnected issues
around scenarios, modelling and communication for effective monetary policy making.
Another aspect we will build into the core of our approach is forecast evaluation. This will help us
continue to adapt and update our understanding of the economy, and to improve our modelling,
analysis and use of data. It will help us assess whether the scenarios we have considered were
capturing some of the key risks missed by the baseline forecast, helping to inform future analysis.
The Bank already does forecast evaluation, for example the discussion of forecast performance
that appears annually in the MPR. And Bank staff continue to produce relevant research in this
area.[12] Building on this we can benefit from more formal and systematic quantification of the
sources of past forecast errors. So we will introduce a new regular forecast evaluation report,
building on the work that we have been publishing in the MPR. The lessons from this work will then
be used to update our analysis and modelling.
Communications
A core part of Dr Bernanke's recommendations was around changing our external
communications to better communicate uncertainty around how the economy may evolve and what
that means for monetary policy.
Dr Bernanke recommends that we 'move cautiously' in adopting changes to communications. He
is right, not least because of the importance of clear communication for monetary policy. A
landscape with a baseline forecast and scenarios brings huge opportunities for communicating
uncertainty, but also challenges on clarity.
Clear communication is a key part of ensuring trust in what we do. And by increasing
understanding of our reaction function, it can improve the effectiveness of monetary policy. And we
know that the simpler the communication, the better.[13]
Substantive changes to our external communications will take time. One challenge is how to
communicate uncertainty in the best way possible. The fan charts were a major innovation when
they were introduced in the 1990s, but I agree with Dr Bernanke that there are better ways to
convey uncertainty.
Scenarios will help us here, they will enable us to provide narratives about how the economy may
differ from the baseline projection, why, and what that would mean. But we will need to draw on the
advice of others to communicate the degree of uncertainty and the balance of risks effectively.
And that may include learning from disciplines other than economics.[14]
Implementing our new approach
These changes will require a substantial improvement in our technology. This was Dr Bernanke's
first recommendation, and one to which he assigned a high priority.
With technology changing rapidly and the challenges of recent years we have slipped behind the
frontier. Dated technology impedes the ability of Bank staff to support the MPC because even
some quite routine analytical tasks involve a great deal of manual processing. It also impedes our
ability to draw on new and different types of data.
Of course, data are the lifeblood of our policy analysis: we are all data obsessives on the MPC.
The evolving data help us gauge the forces that are acting on the economy and are key to our
assessment of the medium-term outlook and risks. This is an exciting area of innovation. For
example, the digitisation of transactions means high-frequency and granular data are increasingly
available, and the data technology to process such data is also evolving rapidly.
We have an extensive work programme well underway. This is the largest modernisation of our
time-series data capabilities in 25 years. And is part of a more general transformation
programme to modernise the Bank's data infrastructure (Benford, 2024a) including moving to the
cloud and exploring how AI can make us more effective and efficient.
We are taking a root-and-branch approach. One imperative is that staff and policymakers can
quickly access the right data and understand their lineage and quality, and to this end we are
upgrading our metadata and data management models. This is painstaking work - we have
around three million data series to migrate - but essential to lay the foundations for the analytical
technology that sits on top of it.
We are developing a new platform that will provide a modern environment in which Bank staff can
develop and maintain models. We will be able to automate the running of models, the
dissemination of their outputs and the production of diagnostics on their performance. This will
both save staff time and provide the analytical flexibility needed to support our ambitions for
forecasting and scenario analysis.
As well as investment in technology, we are also investing in people. I've been enormously
impressed with the expertise, judgement, skills, and dedication of Bank staff since I joined the
institution in the summer. I've seen a huge amount of high-quality analysis.
In the near term, as we ramp up our technical capabilities, we are planning a sizable expansion in
these areas, providing new opportunities for existing staff and through external recruitment. So
come and be part of it and work with us. We will shortly begin advertising for senior positions and
will have more job openings to come. If you are interested, get in touch.
Conclusion
So let me conclude.
The UK economy has made good progress on disinflation. The shocks that drove inflation up have
dissipated and inflation has returned to around target. But the more persistent components of
inflation and uncertainties around how the labour market will evolve are cause for concern. So we
need careful observation of all the relevant economic data and intelligence as we seek to
gradually reduce policy restriction.
We are making progress in responding to the Bernanke Review. Modernising our technology and
time series data capabilities. And we tested developing some different narratives for the economy
and their underlying economic structures in the November policy round.
But we have a long way to go. We are undertaking an ambitious and necessary transformation in
our