The deputy governor of the Bank of England warned yesterday that inflation would rise to "well over" 4 per cent this year and that the twin threats of rising prices and economic slowdown could cause a recession.
Sir John Gieve said that the rising cost of essential items such as food and petrol were driving up people's expectations of inflation. The more that expectations of rising inflation become embedded in wages and prices, the greater the cost will be in unemployment and slower growth, he said.
Consumer price inflation jumped to 3.8 per cent in June, the highest since the Bank gained independence over interest rates, as the price of food and energy continued to surge.
"The peak monthly rate will depend on the exact timing of energy price rises but we are expecting inflation to be well over 4 per cent for much of the rest of the year," Sir John said in a speech. At the same time, he added: "Data suggest that the economy is already slowing fast."
In a question-and-answer session after his speech at the London Stock Exchange, Sir John said the economy was "quite a long way" from the end of the slowdown. The Bank did not forecast recession as its central projection in its May forecasts but had shown it was a possibility. "I can't rule recession out," he said.
The Monetary Policy Committee kept interest rates on hold this month as members elected to wait and see how the balance of risk of rising prices and slowing growth would play out.
Unemployment had its biggest rise since the recession of the early 1990s in June as the number of people out of work and claiming benefits jumped for the fifth month running by a bigger-than-expected 15,500. The figures increased hopes that the Bank would cut rates to combat the slowdown.
Sir John said the MPC was watching the effects of the slowdown carefully and would seek to balance the risks of inflation and slowing growth. But he stressed that, though rises in commodity prices were being fuelled abroad, UK inflation would ultimately be determined by monetary policy.
"I can assure you that we will do whatever it takes to bring inflation back to target in the medium term," Sir John said.
He said the Bank's handling of the re-emergence of inflation and the economic slowdown was complicated by the financial crisis. Tightening credit conditions had offset the Bank's three interest rate cuts since December and the squeeze on lending is set to intensify, he said, adding that the Bank would be cutting rates to address the freeze if inflation were not so high.
In a further sign of the lending drought and housing slowdown, gross new mortgage lending fell 3 per cent in June to an estimated £23.8bn – a 32 per cent decline from June 2007, the Council of Mortgage Lenders said yesterday.
"The year-on-year decline has gathered pace in recent months; lending in the first quarter of 2008 was down 11 per cent on 12 months earlier, while the second quarter was down 21 per cent," the CML said.
The minutes of the MPC's meeting will be keenly watched on Wednesday for divisions between its members.Reuse content