The Governor of the Bank of England last night tried to reassure markets and cash-strapped consumers that rising prices would ease soon, after inflation hit a three-year high last month.
Defending the Bank's decision to pump more money into the economy despite rising prices, Sir Mervyn King said the eurozone crisis threatened Britain's recovery and required action by the Bank.
Sir Mervyn told an audience in Liverpool: "Inflation should fall back sharply early next year. A persistent margin of spare capacity in the economy, and the recent deterioration in demand prospects linked to the crisis in financial markets, will add to the downward pressure on inflation in the medium term. So it is the outlook for inflation, rather than its current rate, which explains the MPC's decision to resume asset purchases."
The Governor blamed temporary spikes in the cost of energy, VAT and imports for a surprise jump in consumer price inflation (CPI) to 5.2 per cent last month. The rate of increase outstripped economists' forecasts and was a sharp rise on 4.5 per cent in August.
Last month's figure – a joint high since CPI was adopted in 1997 – also hits the Chancellor's debt-reduction target. September's inflation number will be used to increase benefit payments from April and the state pension.
Sir Mervyn admitted the Bank was grappling to balance the need for short-term stimulus measures, such as the £75bn of quantitative easing (QE) announced this month, and the long-term requirement to cut the country's debts.
The Bank's critics accuse it of stoking inflation, which will further erode Britain's living standards. Rising prices have hit household budgets with a knock-on impact on retail sales, risking a further slowdown as growth appears to be grinding to a halt.
The Government's Office for Budget Responsibility had forecast September CPI at 4.3 per cent. The difference means government spending on benefits and pensions will be £1.2bn higher next year than previously forecast, according to the IPPR think-tank.
Tony Dolphin, a senior economist at IPPR, said: "The Chancellor's self-imposed deficit targets have just become that bit harder to achieve."
Mr Dolphin said inflation's impact on household finances had cut consumer spending, which in turn reduced growth and threatened rising unemployment. The UK is particularly exposed to this scenario because consumer spending accounts for about two-thirds of the economy.
In his speech to an Institute of Directors' dinner, Sir Mervyn rejected calls for the Bank to extend its asset purchases from gilts to corporate bonds, arguing that gilt purchases allowed money to percolate throughout the economy.
The Governor said the slowing world economy, especially in the eurozone, stalling trade and rising unemployment threatened Britain's plan to revive the economy.
He warned that countries needed to tackle underlying global imbalances, with surplus countries such as China, Japan and Germany needing to import more to help deficit countries, including the US and UK, increase their exports and tackle debt. "Time is running out," he warned.Reuse content