'Determined' King predicts sharp fall in inflation

The Governor of the Bank of England yesterday confidently predicted that inflation would fall sharply in the coming months, and vowed that the Monetary Policy Committee was "completely determined" to bring it back to target.

Mervyn King, who was last week forced to write his first open letter to Gordon Brown after inflation surged to 3.1 per cent, blamed rising energy prices for the unexpected spike. A letter of explanation is required if inflation veers more than one percentage point away from the 2 per cent target.

"Most of the measures of inflation expectations remain close to the target," Mr King told MPs on the Treasury Select Committee, stressing the need to look beyond short-term volatility. "There could be quite a sharp fallback in inflation over the next four to six months. We are completely determined to bring inflation back to target. That's our purpose in life."

The comments, made during Parliament's enquiry into the first 10 years of the MPC, reinforced expectations that interest rates will be lifted by a quarter-point to 5.5 per cent in May. But there were no clues as to whether rates will need to rise further, to 5.75 or even 6 per cent as some commentators have suggested.

Mr King denied his letter to the Chancellor was evidence that monetary policy had failed. He said it was a chance to state publicly the reasons for the rise in inflation and set out the MPC's plans to tackle the increase. "It's not routine in the sense that it happens every month, nor is it something we would expect to be associated with what you might call a failure of policy. A 1 per cent deviation from the target is actually very small relative to the movements in the past," he said.

The Governor rejected accusations that the MPC had ignored consistently high money supply growth, allowing asset prices to rise too fast and fuel inflation. A group of leading economists, including the former MPC member Charles Goodhart, wrote in a letter to the Financial Times yesterday that inflation would be above target in 2008 and 2009 unless money and credit growth slowed appreciably.

"In the global capital markets where money can move freely, what determines asset prices in the UK is very much what is going on around the world," Mr King said. "And in the last few years, there's been a sharp fall in interest rates and risk premium."

Paul Tucker, the Bank's executive director for markets, also denied that they had been dangerously complacent about money growth. "I see [money growth] as an amber light. I don't think the relationship between money and inflation data over the past 30 years has been particularly reliable," he said.

All nine members were happy with the way the MPC operated and satisfied that the set-up worked well. There was, however, some concern about the secretive appointment process of external members by the Chancellor. Some felt it would be better to advertise the position and draw up a list of potential candidates.

An excellent first 10 years, says City

By Jane Padgham

It is a cruel irony that as the Bank of England's Monetary Policy Committee should be celebrating an excellent first decade, it is being berated from all quarters for allowing inflation to climb to the heady heights of 3.1 per cent. It has one unlikely ally, however. Known more for its cynicism than its praise, the City yesterday applauded the MPC for a job well done.

"The MPC has been nothing short of excellent," said Philip Shaw, chief economist at Investec. "Barring last month's increase, it has kept inflation within one percentage point of its target for the entire 10 years it has been in existence. It has acted pre-emptively when needed, sometimes against City opinion."

Geoffrey Dicks, chief UK economist at Royal Bank of Scotland, gave the committee 9 out of 10 for its achievements. "Compared to where we came from, they've done an outstanding job," he said. "No one has rocked the boat, they've maintained a united front, and the whole thing has been conducted in an atmosphere of mutual respect."

Also awarding 9 out of 10, Vicky Redwood, UK economist at Capital Economics, said: "Some say that the MPC has been lucky, but it has had to deal with a fair amount of shocks and coped well." In the past 10 years the committee has grappled with challenges ranging from the Asian financial crisis to the bursting of the dot.com bubble, all the while ensuring continuous economic growth and keeping inflation relatively stable.

That is not to say its performance has been flawless. Arguably, inflation would not have busted 3 per cent last month if rates had not be cut in August 2005 - a decision, incidentally, that was opposed by the Governor, Mervyn King. A rate hike in June 1998 on the back of strong earnings figures also smacked of panic. But as Mr Shaw points out: "When you have to go back so far and scratch your head about individual decisions, it's a sure-fire sign that the MPC has done well."

Mr Dicks said that if he has one criticism, it is that the MPC tends to raise or cut rates one step too far. "They steer by the rear-view mirror rather than looking ahead, responding to things that are already water under the bridge," he said. But he added that even the MPC could not have foreseen the sharp rises in energy and food prices that have boosted inflation recently.