What the financial crisis started, commodity prices will finish: new challenges to monetary policy in the UK

Consumer price inflation is increasingly tied to trends in commodity market prices and products imported from emerging economies and its nature is different from the past. Currently, the financial crisis and its negative consequences represent the primary problem for policy makers in stabilizing all economies. However, the food crisis should not be forgotten since the dynamic of the structural problems of commodity prices have accelerated recently. Therefore, looking beyond the present crisis, we can expect other challenges to emerge, one of which is a possible resurgence in increases in food and other commodity prices.
Inspired by Boughton and Branson (1991), Sims (1992) and Hanson (2004), who identify the importance of the role of commodity prices in consumer price inflation in the USA during the 1980s, our study provides an up-to-date analysis of the ability of the food price index to improve inflation forecasts by reducing the forecast error over the period 1992 – 2012. The results of our stochastic model of the inflation forecast show that the inclusion of oil prices into the forecast significantly increases the forecast error while the inclusion of food prices reduces the forecast error.
This paper has potential implications for future studies of the challenges of forecasting inflation in the UK and may also contribute to a greater understanding of the importance of food prices in the UK by bringing commodity prices back into the discussion.