ContextSpeech by the Governor of the Bank of England at the Reykjavík Economic Conference 2026 in Iceland.
Why it mattersExplains how scenarios and open letters will now shape UK monetary policy after the Bernanke Review.
- The world is unpredictable, making forecasts less reliable.
- Energy shocks force a balance between inflation and output stability.
- Rate changes act with long delays.
- Build scenarios into monetary policy after the Bernanke Review.
- Use open letters to explain inflation deviations.
- Keep inflation expectations anchored while managing volatility.
Read the speech summary
1. Scenarios for an unpredictable world
At the Reykjavík Economic Conference, the Governor of the Bank of England recalled that a year earlier he had explained how, after Ben Bernanke's review of its forecasting, the Bank would use scenarios to explore how shocks spread to inflation and how policy might react. That foresight proved useful: the Middle East conflict has curbed traffic through Hormuz and damaged energy facilities, a large negative supply shock for the world.
2. The shock to UK inflation
Before February, UK inflation was heading back to the 2% target from April, and with slack building and a softer labour market, further rate cuts were likely. Instead April inflation reached 2.8%, with household energy adding 0.8 point more than expected, and it should rise further as utility bills and supply-chain costs climb. As an energy importer, Britain faces a loss of real income that policy cannot prevent; the outcome depends on whether Hormuz reopens and infrastructure is repaired. The Bank's task is to stop inflation from becoming entrenched and bring it back to 2% over the medium term.
3. A flexible target and the lambda question
Since the 1998 Act, the Bank sets policy independently to achieve price stability, under an annual remit from the government and accountable to Parliament, which protects the promise of low inflation from political temptation. The 2% target applies at all times, but the remit accepts that returning to it too fast could cause unwanted swings in output. It does not say how much weight output should get, the parameter economists call lambda, which makes the remit an incomplete contract leaving the committee constrained discretion. He sees this as deliberate: the right weight depends on the shock, high when a temporary price jump can be ignored, low when expectations are at risk. When inflation deviates by more than one point, the Governor writes an open letter to the Chancellor. Compared with a dual mandate, the UK framework puts price stability first but leaves more freedom in managing trade-offs.
4. Applying it to the energy shock
Direct energy effects are usually looked through, since rate rises would hit after the shock fades and would require extra slack to offset them, so lambda is high there. Indirect effects through supply chains last longer and justify a moderate weight. Second-round effects, where higher expectations feed wage claims and then prices, deserve a low weight, but they are uncertain and slow to appear, so the Bank cannot wait for proof yet risks overreacting. Given economic weakness, tolerating temporarily higher inflation is reasonable, but that tolerance would shrink if second-round signs emerged.
5. The current decision
The April report presented three scenarios without a central projection or probabilities because of the unpredictable conflict, covering its length, the scale of energy price rises and the risk of persistence. Holding Bank Rate at 3.75% was an active choice: removing expected cuts has already tightened conditions, with mortgage rates up. Weak activity should limit second-round effects, though they would grow with larger and longer energy price rises, and policy will be adjusted as events unfold.