Bank Of England Head Warns Of Rampant Inflation

The Age

Thursday January 24, 2008

Svenja O'Donnell

BANK of England governor Mervyn King has warned that inflation may this year match the fastest pace in at least a decade - a sign that policymakers have limited scope to cut interest rates.

"To put it bluntly, this year we are probably facing a period of above-target inflation and a marked slowing in growth," Mr King said in a speech yesterday.

"It is possible that inflation could rise to the level at which I would need to write an open letter of explanation, possibly more than one, to the Chancellor."

If inflation strays from the target by more than 1 percentage point, British law requires the governor to write to the Chancellor of the Exchequer detailing the reasons why, and what the bank plans to do about it.

The remarks suggest the central bank may cut the benchmark interest rate less than economists predict, falling short of the US Federal Reserve's emergency reduction.

In the decade that the bank has guided monetary policy, the rate only once strayed more than a percentage point from the target, which is 2%. It reached 3.1% in March 2007.

"We face a difficult balancing act in the course of 2008," Mr King told executives in Bristol, in the south-west of England. "But we start the year in a position in which bank rate, at 5.5%, is probably bearing down on demand."

All 30 economists in a recent Bloomberg News survey expected the Bank of England to reduce the benchmark interest rate next month by a quarter point to 5.25% after cutting it for the first time in two years in December.

The survey also showed most economists expected the rate to fall to 4.75% by the end of 2008.

Mr King's outlook contrasts with Chancellor of the Exchequer Alistair Darling's view that the central bank has "room for manoeuvre" to lower interest rates.

"If you look at the last minutes of the meeting, they are optimistic in relation to inflation," Mr Darling said earlier this month.

The US Federal Reserve yesterday slashed the benchmark by 0.75 percentage points in an unscheduled decision after sharemarkets from London to Hong Kong tumbled, amid increasing signs of a US recession.

"Concerns about the implications of a credit crunch, not only for the health of the US but for the world economy, lie behind the sharp falls in global equity markets over the past week," Mr King said. "So the next year will pose economic challenges for all of us - more so than at any time since the Bank of England was given its independence in 1997."

Growth in Britain is showing signs of slowing. The economy probably expanded 0.5% in the fourth quarter, the least in two years, according to a Bloomberg survey. The British Government was due to release that growth data last night.

Mr King's comments echo remarks by his deputy, John Gieve, who said last week that policymakers faced "difficult judgements" as they weighed the risk of slowing growth and the threat from consumer prices. Mr Gieve said inflation might be "well above" the 2% target in coming months, after it exceeded the goal throughout the past quarter.

After data showed last April that the rate reached 3.1%, Mr King wrote that policymakers were "determined" to get inflation under control, language he repeated yesterday.

Mr King, whose five-year term expires on June 30, has come under fire for his handling of Britain's worst banking crisis in more than three decades. Prime Minister Gordon Brown would not rush a decision on whether to renew Mr King's term, Bryan Davies, a government minister who speaks for the Treasury, said this week.

Mr Brown faces mounting criticism that Britain may suffer more than other European economies from the credit rout, because households are more indebted and the Government is less able to stimulate the economy. Mr Brown's standing with voters has fallen behind David Cameron's Conservative Party partly as a result of the economic problems.

The housing market is grinding to a halt as British consumers struggle to repay record debt. "In 2008 it is likely a less buoyant housing market will go hand in hand with slower growth of consumer spending," Mr King said.