Bank eases fears of early interest rate rise despite stubborn inflation

A senior policymaker at the Bank of England has indicated that persistent increases in inflation and inflationary expectations in Britain does not mean that interest rates will rise earlier than expected.

As the Bank's Monetary Policy Committee prepares to meet next week for its next decision on rates and the direct injection of money into the economy, known as quantitative easing (QE), the newest member of the MPC, Adam Posen, warned that events outside the committee's control would govern the recovery.

"If we are fortunate, our present monetary stance, combined with the UK's natural tendency to recover and with sustained global growth outside of Europe, will be sufficient to get the UK to the good outcome," he said.

"In that state of affairs, I would be only too happy to vote for an interest rate increase."

But Mr Posen added: "I am not as confident that we will get to that favourable situation, and that much of what determines our outlook will take place beyond our borders and certainly beyond the MPC's remit".

Mr Posen's comments echoed the measured tone of remarks made by Paul Fisher, the Bank's executive director for markets, earlier this week, when he warned that tightening monetary policy rapidly would risk "stifling the nascent recovery".

Mr Fisher also stressed the MPC's established policy of seeking to see through one-off boosts to inflation such as sterling depreciation, VAT rises and commodity price inflation, saying it was "sensible not to try to offset the recent rise in inflation by tightening policy".

Mr Posen did, however, also echo the fears that inflationary expectations in Britain had become "de-anchored" from the 2 per cent official target as the public experience of above-target inflation and publicity about aggressive QE and fiscal stimulus filled the headlines. Inflation has been above target in 23 of the past 29 months and Britain is the only one of the major advanced economies to have seen core inflation increase. Such an unusual development, argues Mr Posen, cannot be explained solely by the deprecation of sterling or other special factors often cited by the Bank's Governor, Mervyn King.

Mr Posen concludes: "I am forced to consider changes in the anchoring of inflation expectations as the source of the upward creep we have seen in UK inflation of late... It is naïve or disingenuous for us on the MPC to pretend that such a sustained series of above-target outcomes and forecast errors would have no impact." Recent polling evidence supports Mr Posen's view.

Fears about inflationary expectations and the persistence of the UK's inflationary tendencies are clearly spreading in the MPC, and were behind the unexpected vote against the consensus by another external MPC member, Andrew Sentance, at the last meeting, when he urged a 0.25 per cent rise to 0.75 per cent.

Spencer Dale, the Bank's chief economist, voted against a QE increase in November because "there was also a risk that further substantial injections of liquidity might result in unwarranted increases in some asset prices", according to the MPC minutes.

Mr Posen concludes that "a small slow upwards creep in inflation expectations is not worth panicking over, and certainly is not a reason to tighten policy when the forecast argues against so doing. And that kind of creep is indeed what I believe that we are seeing."

City economists think rates will stay at current levels for most of this year.