Mervyn King warns Chancellor inflation could hit 4%

18 June 2008 / by Joy Tibbs
An open letter sent to the Chancellor Alistair Darling by Bank of England governor Mervyn King confirmed that inflation had breached the three per cent boundary.

The letter, sent yesterday, alarmingly suggested that rising food and fuel prices could lift inflation above four per cent this year.

Figures from the Office for National Statistics (ONS) showed that consumer inflation rose 3.3% year-on-year in May, the fastest rate since the Consumer Prices Index began in 1997, and far above the Government target of two per cent.

Picking up on this, Mr King wrote that: "Inflation is likely to rise significantly further above the 2% target in the next six months or so." He attributed the prospective rises to higher oil prices, rising wholesale gas prices and the decline of the pound.

"As things stand, inflation is likely to rise sharply in the second half of the year, to above 4%," he wrote.

Mr Darling responded, also in a letter, and registered the governor's concerns. However, he claimed that: "Faced with the recent sustained commodity price shocks in oil and food, the rise in inflation has been extremely moderate compared with the behaviour of the economy in the 1970s and 1980s."

Commenting on the letters, Paul Niven, head of asset allocation at F&C Investments, wrote: "In the view of the Chancellor, what we are seeing is a temporary spike in the inflation rate but this should decline in due course and of encouragement is the view that wage settlements are relatively subdued."

In conclusion, he wrote: "The Governor seems to have stated the view that a crunch of the domestic economy to drive down inflation expectations is both unnecessary and undesirable. This view will only hold so long as wages remain muted. If these do become unhinged then the market expectations which we can currently observe, for several rate hikes, will come to fruition."

Meanwhile, New Star's Simon Ward said: "It is disappointing that there is no acknowledgement of the role of excessive monetary growth in accommodating the impact of these pressures on domestic prices.

"Unsurprisingly, the letter implies current official rates are appropriate, balancing upside and downside risks. Any hint of a bias would have raised the question of why rates were not moved at the meeting less than two weeks ago.

"An especially shocking feature of today's figures [from the ONS] was the further surge in RPIX inflation (i.e. excluding mortgage interest rates) from 4.0% to 4.4% - 1.9 percentage points above the old 2.5% target for this measure."

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