Mervyn King: 'There is evidence of a significant margin of spare capacity in the economy'
Wednesday, 16 February 2011
Inflation 'to increase sharply'
The Governor of the Bank of England, Mervyn King, has said inflation will rise sharply in the first half of this year before falling back next year.
But he said there were "large risks" that inflation could overshoot or undershoot the Bank's 2% target.
He reiterated his belief that external factors, such as rising food and energy prices, are the main cause of rising prices in the UK.
Mr King said growth would be weaker than the Bank forecast in November.
He said that once cost pressures from high commodity prices subside, "CPI inflation will then fall back. But the extent to which it will do so is uncertain, and there are large risks in both directions."
On Thursday, official figures showed that inflation, as measured by the Consumer Price Index (CPI), rose to 4% in January from 3% in December. Measured by the Retail Price Index (RPI), which includes mortgage interest payments, it rose to 5.1% from 4.8%.
Mr King was forced to write a letter to the Chancellor, George Osborne, to explain why CPI inflation was twice the Bank's target rate.
Analysis
"Only time will tell. The judgements are difficult."
These words from Mervyn King, from his opening remarks at the media conference, summed up the Bank's dilemma.
Raising interest rates too soon could stifle a fragile recovery - and the Bank has revised down its growth projection for 2011.
Continued high inflation could push up inflation expectations - which would force the bank to intervene.
The governor and his colleagues will have several more uncomfortable months and tricky decisions.
The governor said if businesses and households expected that high inflation was here to stay, prices and wages might rise even more quickly.
On the other hand, as the effects of the rise in VAT to 20% implemented in January and imported cost pressures began to diminish, there was a risk that weak growth "will push inflation well below target," he said.
Mr King said there were "real differences of view" in the Bank's Monetary Policy Committee, which sets interest rates, about "the likely path of inflation in the medium term".
Two members, Andrew Sentance and Martin Weale, have already voted to raise interest rates, currently at a record low of 0.5%, to combat rising prices.
The split reflects the wider debate among economists, with some arguing that rates should be increased to prevent inflation rising further, and others maintaining that a rate rise would jeopardise the fragile economic recovery.
In light of the latest figures showing inflation rising faster, and Mr King's letter to the chancellor, more observers now believe the Bank could raise rates sometime over the summer.
Mr King said the recovery was "unlikely to be smooth", while the Bank's economic growth projection for most of this year was now "weaker" than it forecast
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