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David Buik Comments: Mervyn King Admits Surprise As Inflation Stays Above 3% - Evening Standard

Mervyn King today admitted he was “surprised” by the stubbornly high level of inflation and warned it will remain above target until the end of next year.

The Governor of the Bank of England was forced to write another letter to the Chancellor, his eighth in three years, to explain why inflation was so high after the Consumer Prices Index hit 3.1% in July. That was down slightly from the 3.2% seen in June and the third fall in a row but still well above the 2% target set by the Treasury. “The recent strength of inflation has surprised the monetary policy committee,” wrote King in a letter to George Osborne. “Inflation is now expected to remain above the 2% target until the end of 2011 — about a year longer than projected in May.”

Despite the persistently high levels of inflation, the Bank is not expected to raise interest rates soon for fear of tipping the economy back into recession. King blamed inflation on the VAT increase from 15% to 17.5% in January and the looming second hike to 20% proposed by Osborne for the start of next year. He said prices were being pushed up by the high cost of oil and the fall in sterling over the past three years, which has driven up the cost of imports.

Above-target inflation has prompted Bank hawk Andrew Sentance to vote for a gradual rise in interest rates in recent months.

Others on the MPC are unconvinced, however, and it is thought that the more dovish members may even be calling for a second round of quantitative easing to pump more money into the economy. King again appeared to side with those opposed to interest rate hikes today. He said: “As the effects of higher VAT, energy price rises and import price increases drop out of the 12-month comparison, inflation should fall back, probably to below the target, reflecting the influence of spare capacity in the economy.” The Governor said it is “difficult to judge” how far and how fast inflation will fall and warned of “substantial risks in both directions”.

However, King said: “The MPC's central view remains that inflation in the medium term is likely to be close to, or a little below, the target.” Osborne agreed. In his reply to King, the Chancellor wrote: “Inflation is likely to fall back to a little under 2% in early 2012.”

City commentator David Buik, of BGC Partners, said: “The Governor seems very happy that the slack in the economy will eventually take inflation down to 2% by 2012. “Hell has a better chance of freezing over than rates being increased for some months to come.

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