Bank’s gloomy inflation forecast

Jun 18 2008 by Alex Turner, Liverpool Daily Post

THE Bank of England yesterday warned that rising energy and oil prices could push inflation above 4% this year.

In an open letter to the Chancellor after official inflation hit 3.3%, the Bank’s Governor, Mervyn King, said he had revised previous forecasts upwards due to a 15% rise in oil prices during the past month and the prospect of higher gas and electricity bills.

Mr King’s latest forecast puts the Consumer Prices Index at more than double the Bank’s 2% target, and raised fears of interest rate rises.

The Governor said that the course of interest rates needed to meet the target was “uncertain'”. He added that the Bank’s Monetary Policy Committee (MPC), which sets rates, would make month-by-month judgments on the course of borrowing costs.

A City economist told MPs at a Treasury Select Committee that interest rates should not be increased to calm soaring inflation if the Bank of England is to avoid damaging the economy or knocking already fragile consumer confidence.

Roger Bootle, managing director of Capital Economics, said: “Out there in the real world, I’m not sure ordinary people would make a connection between monetary policy and inflation, at least as far as homeowners are concerned it’s just another thing that sounds bad.

“What it would do is increase expectations that the economic outlook may be quite poor. I suspect it would need quite a time to translate into lower inflation expectations.”

Howard Hackney, a Liverpool-based partner at Grant Thornton, agrees that interest rates should not be increased, but because he believes it is too late.

“My view is I’m convinced a recession is coming because I think we have talked ourselves into it,” he said. “Everyone is expecting it and we usually get what we expect even though I don’t think we need to have it.

“If one expects recession there should be no need to raise interest rates, so it depends on whether the Bank of England expects a recession.

“I don’t think they will do anything with rates. It will stick or rise, but I think it will stick for the time being. The inflation figures push for an interest rate rise but the housing market doesn’t, it is finally balanced.

“I don’t think we are in recession yet, but we may see the two consecutive quarters of negative growth in September and December, or December and March. It’s not clear when we will get the negative growth, but it’s not imminent as yet.”

The MPC has faced a balancing act between cutting rates too sharply and adding to inflation risks and keeping rates too high and risking a sharp slowdown of the economy.

Soaring fuel and food prices pushed inflation above 3% in May to its highest reading since records began more than 11 years ago.

The Consumer Price Index rose by 0.3 percentage points to 3.3% during May, the highest reading since the measure was first reported in January, 1997. The Governor is forced to write a letter if inflation moves more than 1% above or below the Bank’s target.

In contrast to his letter last year to former Chancellor Gordon Brown, Mr King said yesterday’s letter was likely to be the first in a sequence as inflation remained “markedly above target” until well into 2009.

Mr King added that inflation should peak around the end of the year and begin to fall back towards its target “in the absence of further unexpected increases in oil and commodity prices”.

The FTSE-100 Index rose more than 120 points as fears of imminent interest rate hikes to tackle inflation receded before closing nearly 70 points up, at 5,862 points.

The British Chambers of Commerce said raising rates in response to a short-term surge in commodity prices would be “totally misguided”.

The TUC’s head of economics, Adam Lent, said: “Putting up interest rates now would do nothing to damp down inflation and would instead slow the economy. There is no point in the UK economy taking medicine with nasty side effects if it doesn’t produce a cure.”

BILL GLEESON: PAGE 8

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