The third-quarterly inflation report issued by the UK’s central bank suggested the country would narrowly escape a triple-dip recession. Presenting the report, Sir Mervyn said there was cause for optimism, despite the worse-than-expected contraction in GDP in the fourth quarter of 2012.
However, households were braced for further pain as the Bank said the inflation outlook had worsened since the last report in November and was expected to rise to 3 per cent or more by the summer and remain above the 2 per cent target for another two years.
Even though inflationary pressures are expected to last until early 2016, the Bank indicated there was no prospect of interest rates tightening soon.
Sir Mervyn said: “Attempting to bring inflation back to target sooner would risk derailing the recovery and undershooting the target in the medium term.
“So long as domestic cost and price pressures remain subdued, we will continue to look through the temporary, albeit protracted, period of above- target inflation in order to support the recovery.”
The Bank added that higher tuition fees and energy costs added 1 per cent to inflation at the end of last year and would continue to drive inflation higher, making it more difficult to bring the Consumer Price Index measure of inflation back down towards the 2 per cent target.
The forecast means one of incoming Bank governor Mark Carney’s first tasks could be to write a letter to the Chancellor to explain why inflation is more than one percentage point above target.
The Governor must write an open letter of explanation to the Chancellor if inflation misses the target (in this case 2 per cent) by more than one percentage point in either direction. Letters have to be written once every three months thereafter until inflation gets back within range.
Sir Mervyn admitted that the Bank’s £375 billion quantitative easing programme had become less effective, but said that it stood ready to do more to support the recovery.
The Funding for Lending Scheme (FLS) – launched last year to provide cheap money to lenders – is among the tools being used to boost the economy and yesterday’s report added to recent encouraging signs that it was beginning to work.
Lending costs are starting to come down and Halifax house prices recorded their strongest quarterly rise in three years in the three months to January.
However, Sir Mervyn said there needed to be a recovery in the global economy for a return to stable growth. He said: “The experience of the past five years has shown us that UK monetary policy alone cannot guarantee a stable path for our economy, especially after a banking crisis.
“The challenge of rebalancing the world economy means that our road to recovery will be harder than in 1993. But recover we will.”
The Bank said a “slow but sustained recovery” would be supported by an easing in wider global conditions as well as the FLS scheme, which is boosting credit for consumers and businesses.
Its forecast shows annual GDP rising to about 2 per cent by the end of 2014 and remaining in positive territory, despite some volatility in the year ahead.
Sir Mervyn said: “The UK economy is set for a recovery. That is not to say the road ahead will be smooth. This hasn’t been a normal recession and it won’t be a normal recovery.”