King plays down rate-rise rumours as number of jobless nears 2.5 million

The economy faces a "difficult period" of higher inflation and lower growth than previously expected, the Governor of the Bank of England cautioned yesterday.

Mervyn King's warnings came as the latest figures showed an unexpected lengthening in the dole queues, up 44,000 to just under 2.5 million, with youth and long-term unemployment both rising. "The recovery is unlikely to be smooth," Mr King said. City economists suggested that the Bank was "not in a hurry" to raise interest rates, despite the prospect of inflation rising to between 4 and 5 per cent this spring; other experts, though, still expect the base rate to rise in May, from the current 0.5 per cent to 0.75 per cent, pushing tracker and variable rate mortgage bills up with it. Such a move could have a devastating effect on a fragile housing market.

However, the Bank says growth will pick up to about 3 per cent a year next year, the best since the recession began. Mr King rejected the idea that the Bank should have raised rates sooner to fight inflation as a "futile gesture": "When setting policy," he said, "it is important to distinguish between the reasons for the current overshoot of the inflation target and their implications for inflation in the medium term. On the first, only a very much deeper recession could have prevented the price-level shocks which the UK has experienced from pushing inflation above the target. It is the second issue which is relevant to monetary policy today, and there is plenty of room for differing views about the outlook for inflation two to three years ahead."

Pressed repeatedly about the Bank's failure to keep inflation at the 2 per cent target – it has been above 3 per cent for a year, currently stands at 4 per cent and will not return to 2 per cent before mid-2012 on the Bank's latest forecast – Mr King stressed unforeseen short-term factors outside the Bank's control: the increases in VAT and soaring world commodity prices, especially for oil, food and cotton. Mr King said: "Some people are running ahead of themselves in saying that we are pre-announcing, or we're laying the ground, for a rate rise. That decision has not been taken and it won't be taken until we get to the next meeting, or the following meeting... it may be many quarters before we do anything."

Defying critics who claim the Governor has aligned the Bank too closely with the Government's fiscal consolidation plan, Mr King repeated his belief that the country did not need a "Plan B", as has been called for by Labour, and said "there has to be a Plan A". He said: "This country needs a fiscal consolidation... and rebalancing of the economy... I think we should be glad that we're in a position where both these factors are going to operate over the next five years."

His words were closely echoed shortly afterwards by the Prime Minister at Question Time, who told MPs: "This country needs fiscal consolidation to deal with the biggest budget deficit in peacetime. There has to be a Plan A." Mr King and Mr Cameron have both described the recovery ahead as "choppy".

Mr King conceded: "Clearly the fiscal consolidation is going to slow demand relative to where it would have been without [it]. That factor enters into our overall judgement."

The shadow Chancellor, Ed Balls, said: "The Governor says he is downgrading his forecast for economic growth this year and that the fiscal tightening – those cuts – are going to dampen growth in the economy this year. He is completely right about that and... that's very worrying."

Philip Shaw, an analyst at Investec, said: "The tone of the press conference and the Inflation Report convey the impression that the MPC as a whole is not in a hurry to raise rates. If all goes well, rates will not rise until the last three months of this year."

Next week the Bank will publish the minutes of the last MPC meeting, and they are likely to reveal deep division within the committee on what to do next; splits implicitly accepted by Mr King yesterday. In January the minutes showed two so-called hawks voted for a rise in rates, and one MPC member voted to ease policy some more. The swing in voting in February will be watched as a key indicator of the way the wind is blowing in Threadneedle Street – and how soon mortgage bills will start climbing.

INFLATION? WE'VE GOT IT WRONG FOR 12 YEARS

It's official; not only can the British authorities not control inflation, but they can't even measure it. Britain's rate of inflation has been underestimated for 12 years, the Bank of England claimed yesterday. The Bank says a persistent underestimate of the cost of clothing by the Office for National Statistics (ONS) left inflation 0.3 per cent a year lower than it actually was between 1997 and 2009 – significant when inflation was about 2 to 3 per cent. The Bank said the ONS had failed to see how the price of clothes had gone up after seasonal sales because "identical garments are no longer available". The claim shattered normally decorous relations as the ONS hit back: "The ONS has not formed a view on how consumer behaviour has changed over time in regards to clothing purchases. ONS has therefore not published an estimate of what the impact of these improvements would have been, had they been implemented in the past."

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