Much has been said about Brexit’s impact upon output – that increased uncertainty has reduced capital spending and exports. What’s less appreciated is that Brexit might also have long-lasting effects upon inflation.
Of course. Brexit led to higher inflation in 2017 because sterling’s fall raised import prices. In itself, though, that was just a one-off. What's more interesting, and perhaps dangerous, is that Brexit has had a more persistent effect upon inflation expectations.
The Bank of England has been measuring the general public’s expectations every three months since 1999. For the 17 years up to the referendum, such expectations followed a simple rule. The inflation rate people expected in the following 12 months was equal to the rate they perceived in the past 12, adjusted upwards if inflation were low and downwards if it were high*. This rule explained four-fifths of variation in expected inflation, and failed only when the 2009 recession reduced inflation expectations.