Chancellor Alistair Darling needs to provide the Bank of England with clear guidance over inflation if the economy is to stabilise, according to industry expert Peter Spencer. Mr Spencer, who is chief economic advisor to the Ernst and Young ITEM Club, has urged the Government to change its inflation targets.
In relation to inflation figures released on May 13, he said that the: "Inflation figures raise serious doubts about the specification of the inflation targeting regime as well future economic prospects.
"With CPI [Consumer Price Index] inflation now at three per cent and hefty transport, energy and food price increases yet to come, it is now inevitable that the CPI will move and stay well above the target range this summer, requiring the Governor of the Bank of England to write a letter of explanation, probably several, to the Chancellor."
He continued: "There is little that the MPC can do about that at this stage. However, it seems clear that interest rates will be on hold over the next few months, leaving the economy prone to the after-effects of the credit crunch." This news is likely to be received with some disappointment by mortgage
holders, many of whom had hoped the Government would cut rates earlier this month.
Mr Spencer predicts that inaction could have a profound impact on the UK economy. "Public perceptions of inflation are increasing and with inflation moving still higher there is an increasing risk that wage and other second round effects will break out," he said.
"However, monetary and certainly credit conditions remain tight and this should ensure that over the MPC’s [Monetary Policy Committee's] two-year horizon the upward pressure from world food and energy prices is offset by weakness in core inflation. Against this background, upward pressure on prices will continue to mean reductions in disposable income, particularly at the lower end of the income scale."
In conclusion, he said that: "This leaves the government with an important decision to make over the future of the inflation target. One option is to stand by the two per cent CPI inflation target rigidly and accept that this will mean much weaker economic growth and further undermine the living standards of core government supporters.
"Alternatively, the government could make an active choice about the inflation/growth trade-off and raise its inflation target for the next couple of years."
He added that: "The Chancellor must give the Bank a clear steer and accept that the consequences will reflect his position on the trade-off between holding rigidly to the inflation target in the face of a major global shock or supporting employment."
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