Inflation set to stay high for most of 2011, says Mervyn King

Published on Wednesday 28 July 2010 18:00

BANK of England governor Mervyn King warned yesterday that inflation would remain high throughout most of 2011, indicating he is more concerned about the strength of the recovery than spiralling prices.

• Picture: PA

Speaking at the House of Commons, Mr King delivered more tough news for households facing rising costs when he said the inflation rate would remain above the government's 2 per cent target for "much of next year".

Addressing MPs on the Treasury select committee, Mr King said consumer prices index (CPI) inflation had been high for most of the past four years and that trend was unlikely to be reversed in the short term. "The debate is about the appropriate degree of stimulus, not about applying brakes," he said.

The Bank's rate-setters are charged with keeping inflation at 2 per cent, but the CPI benchmark has been above 3 per cent throughout this year. The current rate is 3.2 per cent.

Despite "encouraging" 1.1 per cent growth recorded for the UK economy in the second quarter of this year, Mr King warned we "cannot be confident" the recovery would be sustained. His remarks raised the spectre of "stagflation" - high inflation and stuttering growth.

Despite some calls to raise interest rates in an attempt to crack down on inflation, Mr King indicated he would resist that option for the time being. Andrew Sentance, a member of the bank's monetary policy committee - the body that sets interest rates - has advocated an interest rate hike.

Interest rates have been held at 0.5 per cent for more than a year now in an attempt to reduce the cost of borrowing and get the economy moving again. Mr King said interest rates would eventually return to "more normal" levels, but he added: "I fear there is some significant distance to travel before we can begin to use the word 'normal'."

The Bank of England's approach has been endorsed by Benjamin Williamson, a senior economist with the Centre for Economics and Business Research.

"We believe that inflation will fall to around 1.6 per cent by February 2012," Mr Williamson said.

"If the Bank of England can look beyond the short term, they will come down, so we don't believe there is any need to increase interest rates given that earning growth is so low at the moment.

"The inflation rate is rising in the short term, because of rising oil and commodity prices and the weak pound. That's what is keeping inflation above target. But other factors, such as weak labour costs, are driving inflation downwards and that will eventually bring it down."

CBI Scotland assistant director David Lonsdale said: "While there remain undoubted risks to the economic outlook, the tentative recovery in the UK economy is likely to be sustained, with momentum building next year.

"This reinforces the need for supportive business and economic policies to be at the very heart of the agendas."

BY THE LETTER

If THE 2 per cent CPI target is missed by more than one percentage point on either side – ie, more than 3 per cent or less than 1 per cent – the governor of the Bank of England must write a letter to the Chancellor explaining the reasons why inflation has increased or fallen to such an extent and what the Bank is going to do to bring it back on to target.