We are facing a credibility gap admits Bank's deputy governor

THE Bank of England risks a credibility problem with its inflation-forecasting the longer the core consumer prices index stays above the mid-term target, the deputy governor of the central bank admitted to MPs yesterday.

With inflation at a two-and-a-half year high of 4.5 per cent, Paul Tucker told MPs that he was "one of those that is worried about an upward drift in inflation expectations".

He said: "The longer that inflation remains so high, and we say it's due to another one-off factor, the more the people of this country think we use this 'one-off factor' in a completely different way."

Tucker told the Treasury select committee: "The forces buffeting the economy are all over the place, making it very difficult to determine what is going on. We are not happy inflation is so much higher than we forecast. Of course we are not."

His comments came after Michael Fallon, Conservative MP for Sevenoaks, told the BoE team at the committee, led by governor Sir Mervyn King, that the MPC had sharply underestimated inflation since the credit crunch of 2007.

Fallon noted that in quarterly inflation reports since then the average forecast by the MPC had been 1.9 per cent compared with an actual figure of 3.2 per cent. "That is an error of 1.3 per cent," Fallon said.

Spencer Dale, chief economist at the BoE and a rate-setting committee member, blamed soaring commodity prices for some of the shortfall in inflation forecasts. Both he and fellow MPC member, David Miles, told MPs inflation might be above its medium-term 2 per cent target for another two years. Dale has been one of two committee members voting for a quarter-point increase in rates.

Adam Posen, the MPC member who has argued for an increase in the BoE's 200 billion bond-buying programme known as quantitative easing (QE) to get the economy moving again, said the VAT increase to 20 per cent had also helped throw out the BoE's inflation forecasts.

However, Posen was more optimistic than his colleagues about short-term inflation. "I expect it (inflation] to be below target in a year," he said.

The governor told MPs that he had voted against more QE so far because the BoE could be "accused of taking the easy option and made it more difficult to get low inflation in the medium term". However, King also played down the possibility of early interest rate rises amid a fragile UK economy.

Earlier in the day, the Office for National Statistics confirmed its previous estimates that the economy grew by just 0.5 per cent in the first three months of 2011, a modest bounce from the 0.5 per cent contraction in the final quarter of last year.

Household spending declined at its fastest quarterly pace since the second quarter of 2009.