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Bank of England's Mervyn King warns over inflation 28 July 2010
Steven Jackson (about the author)

Bank of England Governor Mervyn King has warned that high inflation will continue to erode earnings power through next year as the economy faces the threat of 'stagflation'.
 
Prices rises have consistently defied the Bank's expectations of a slowdown, adding to pressure on households as wage growth remains weak and the Government introduces a strict austerity package.

The Bank's rate-setters are charged with keeping inflation at 2% but the Consumer Prices Index benchmark has been above 3% throughout the year.

However, addressing a committee of MPs, Mr King suggested that they will be reluctant to try to curb the problem by raising borrowing costs from 0.5 per cent any time soon because of the weakness of the economy.

“There will come a point when we will certainly need to ease off the accelerator and return Bank Rate to more normal levels,” Mr King told MPs today.

“I look forward to that time because it will probably be a signal that there is a smoother drive ahead, with the economic outlook improving in a durable way. But I fear there is some considerable distance to travel before we can begin to use the word ‘normal.’”

Rate rises could spell financial disaster for many

The Bank of England's Monetary Policy Committee (MPC), which slashed interest rates to a record low of 0.5pc during the depths of the recession, faces an acute dilemma on when to begin raising them. Not everyone on the MPC agrees with the Governor that the threats to the recovery present a greater danger than that of rising prices.

And despite "encouraging" 1.1% growth for the economy in the second quarter, the governor warned that we "cannot be confident" the recovery will be sustained, raising the spectre of 'stagflation' - high inflation and stuttering growth.

“We must be careful not to read too much into one number,” King said. “And the wider economic problems around the world underline the fact that we cannot be confident that the recovery in demand, output and employment here in the U.K. will be sustained.”

Steven Jackson of Beatmydebt.com believes that raising interest rates too soon would be a mistake. "There are thousands of home owners who are currently living on a financial knife edge. Incomes have been reduced due to the recession and people have only been able to hold on to their homes because mortgage payments are at all time lows. To increase interest rates would spell financial disaster for these people" he warned.

Rates likely to remain low

Howard Archer, an economist at Global Insight, said "one thing that does look clear is that interest rates are likely to remain very low for a considerable time to come.

"Monetary policy will need to remain loose for an extended period to offset the impact of the major, sustained fiscal squeeze," said Mr Archer.

Mr King also suggested the US has been wrong to prioritise growth over cutting debt levels.

"All countries need to have a credible medium term plan within which they can demonstrate that they will get back to a position in which structural deficits are eliminated and there is a sustainable path for the long-term public finances," he said.

"Not spelling it out is, I think, a problem."

The Bank said austerity measures were part of a painful rebalancing of economies towards the private sector. "I think we are are in for a long haul," said Mr King.

Source: The Telegraph