Bank of England Governor Mervyn King said the current bout of inflation is temporary and price growth will slow “quite sharply” next year, as he defended the bank’s decision to keep its interest rate at a record low.
“We are experiencing a period of uncomfortably high inflation,” King said in Newcastle, England today in his first public speech of the year. “The determinants of inflation further ahead remain consistent with inflation falling back quite sharply next year.”
Inflation has exceeded the bank’s 2 percent target for more than a year, and accelerated to 3.7 percent in December. While King forecast the rate may rise above 4 percent in the coming months due to higher commodity prices and an increase in sales tax, he said the Monetary Policy Committee hasn’t abandoned its mandate for price stability.
“Large — very large — shocks to relative prices are an inevitable part of the real adjustment vital to the rebalancing of the U.K. economy,” he said. “None of this means that we cannot return inflation to the target in the medium term, nor that the MPC has abandoned its commitment to meeting the inflation target.”
King, 62, said slow wage growth, high unemployment and government spending cuts are creating economic “headwinds” that will limit price gains. He also said that data today showing the economy unexpectedly shrank 0.5 percent in the fourth quarter points to a recovery that will be “choppy.”
King’s nine-member committee has split three ways on the future direction of policy. His comments come the day after Andrew Sentance reiterated his call for higher rates and follows remarks by Adam Posen suggesting he may continue a push for more bond purchases.
The bank held the key interest rate at a record low of 0.5 percent and its bond purchases at 200 billion pounds ($316 billion) this month. It will publish the minutes of that decision in London tomorrow. King said the asset plan “has not pushed inflation above target — it has done no more than stabilize broad monetary growth.”
“The MPC has stuck to its remit,” he said. “Credibility was not earned in a year, and it will not be lost in a year. It is the result of experience of a number of years.”
He said the bank was right to keep rates at a record low because increasing them “significantly” would have led to greater unemployment, slower wage growth and a bigger deterioration in living standards.
There is “unhappiness” among many people about the level of inflation as price gains have “squeezed” households’ incomes, he said. There is a “misapprehension” the bank could have prevented this.
“The idea that the MPC could have preserved living standards, by preventing the rise in inflation without also pushing down earnings growth further, is wishful thinking,” King said. Even if last year’s price jump was foreseeable, “it would not have been sensible to pretend that a tightening of monetary policy” would have returned inflation to target.
“Communicating this big picture is not easy,” he also said. “We shall try even harder to explain the basis for policy decisions.”
Nevertheless, the bank is monitoring inflation risks, including a possible further increase in energy prices, according to King, who added that a feed-through to wage settlements “would require a response by the MPC.” While household surveys show inflation expectations have risen, they don’t show that above-target price growth will persist.
“At some point bank rate will have to return to a more normal level,” he said. In the current circumstances, “the right course has been set, and it is important we maintain it.”
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