David Prosser: The Bank's impossible balancing act

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The Independent Online

Outlook It is in this context that Mervyn King, the Governor of the Bank of England, presents his quarterly Inflation Report today. He faces a difficult balancing act. On the one hand, Mr King will be acutely aware of the nervousness about the prospects for growth. On the other, he runs an institution that is mandated to hit an inflation target of 2 per cent, but which hasn't yet managed to bring the rate below 3 per cent this year.

The Bank's public utterances on inflation have at least been consistent. It insists that the consumer price index will, in time, fall back towards the 2 per cent target. In the meantime, the traditional response to inflation, an interest rate increase, is not appropriate for an economy still fighting its way back from the worst recession in living memory.

There are two problems with this analysis. First, there is no sign of the Bank's prognosis being proved right any time soon. Commodity price rises are the immediate threat, but there are reasons to worry further out too – the VAT increase planned for the New Year, for example. Second, the perception of the Bank's competence in the battle against inflation is just as important as its actual performance. There is a limit to how long Mr King can go on promising inflation will eventually come back within range without losing his credibility if it doesn't happen.

Are we at that limit yet? Probably not quite, though one reason why Andrew Sentance, the Monetary Policy Committee member, keeps voting for a small interest rate rise is that he wants to demonstrate that the Bank is still serious about tackling inflation.

The sniping has begun, however. This week alone, for example, there have already been a series of reports carping about the new forecasting model that the Bank is currently building (the implication being that the old one didn't work). The balancing act is getting tougher by the day.

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