Bank's Warning on Inflation Dampens Hopes of Rate Cuts
Sean Farrell; Colin Brown, The Independent (London, England)
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Mervyn King warned last night that price pressures could make the Bank of England miss its inflation target more than once this year as he set out a tough stance that will dampen hopes of a series of interest rate cuts.
The Governor of the Bank of England said higher prices for energy, food and imports may force him to write more than one letter of explanation to the Chancellor because inflation had hit 3 per cent - a point above target. The Bank's Governor has only written one such letter - in April last year - since the central bank gained independence in 1997.
Mr King said the next year would pose more challenges than at any time since 1997 as the Bank faces the twin pressures of rising prices and slowing growth. Tighter credit conditions could slow economic activity sharply, while weaker economic activity and falling asset prices might spark another round of losses for banks and a further tightening of credit, he added. But he said the Bank was determined to keep inflation on track to meet the Government's 2 per cent target. Inflation is already marginally above target, with the consumer price index standing at 2.1 per cent in December.
"It is possible that inflation could rise to a level at which I would need to write an open letter of explanation, possibly more than one, to the Chancellor," Mr King said in a speech in Bristol. He added that higher inflation was inevitable, but that the Bank's task was to ensure that the increase was shortlived. "If inflation expectations were to pick up in the wake of a rise in inflation this year, then only a more prolonged slowdown would allow inflation to return to target," he said.
He said it was not the central bank's job to solve the banking crisis and called on lenders to reveal losses promptly and raise new capital if necessary to restore confidence to the system.
Mr King made his speech on the day that the US Federal Reserve cut its benchmark lending rate by three-quarters of a percentage point to try to ward off a recession.
Amid rumours of concerted action by central banks, the Bank of England indicated it had no plan to bring forward the next meeting of its Monetary Policy Committee (MPC), scheduled for 7 February.
European finance ministers warned against panic, and said European economies were better prepared for a slowdown than the US.
The MPC kept rates on hold this month after voting unanimously for a cut in December. Most economists had believed the Bank would cut rates next month in the first of a series of rate reductions this year. Mr King's warning will weaken those expectations.
Alan Clarke, UK economist at BNP Paribas, said core inflation was under control and that the Bank of England was "in denial" about the severity of the economic downturn to come. "It is a matter of time before the Bank of England realises the downside risks to growth and cuts more aggressively. But it is looking more and more like it is not going to be front-loaded in the early part of this year and will have to wait for the second or third quarter."
Ed Balls, an ally of the Prime Minister, said the Bank of England had scope to cut interest rates to keep the economy afloat. "With inflation low and the Bank of England able to cut interest rates as we saw just a couple of months ago, I think we are in a strong position," he said. …