Governor may be forced to explain low inflation rate

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A member of the Bank of England's rate-setting Monetary Policy Committee (MPC) has given the first public indication that the Bank's Governor may soon have to explain to the Chancellor why inflation is so low and what the Bank intends to do about it.

Richard Lambert, a former editor of the Financial Times and an MPC member, told the Institute of Chartered Accountants in Scotland yesterday: "We are now getting very close to the point where the Governor would have to exercise his letter-writing skills." The rule was made part of the regime when the MPC was formed in 1997 and this would be the first time such a letter would have been sent.

Every year the Chancellor sets a target rate for Consumer Price Index inflation which guides the MPC in setting interest rates. If the actual inflation rate goes above or below the target by more than one percentage point the Governor has to explain. It is currently 1.1 per cent compared with a target of 2 per cent.

Mr Lambert said: "House price inflation seems to be on the turn, and the pace of spending on the high street may cool off more rapidly than had been expected. It now seems unlikely that economic growth in the third and fourth quarters of this year will match the very strong performance of the second, so the pressure of demand may turn out to be less intense than might have been expected. Moreover, the trend of prices in industry's supply chain still looks quite muted."

Mr Lambert warned, though, that there was a considerable degree of uncertainty about the outlook for inflation in the next two years. He said: "The impact of [lower growth] on inflation could at least partly be offset by the recent weakness in sterling and a flattening in the market yield curve in the past few weeks, both of which - should they persist - could help to sustain the level of economic activity. Even with some moderation, the economy may still be growing at somewhere close to trend, and there seems to be little or any slack left in the system. Pressure of demand in the rest of the world could start to push up further on import prices."

Mr Lambert noted that inflation was being held back by a "brutal" retail climate, while low unemployment was not pushing up wage rates as might have been expected. He said: "The employment rate has slipped a little, and the level of inactivity has risen. The number of average hours worked has declined, but for some reason the market doesn't seem to be getting any tighter. At the same time, the pace of regular pay growth in both the public and private sector appears broadly to have flattened out."

Mr Lambert admitted that it was hard to explain this apparent change of mood. But that inflation was set to remain low and stable in the UK despite violent swings in the prices of individual goods and services.