Posen calls for calm as inflation fears rise

Economics Editor,Sean O'Grady
Friday 17 December 2010 01:00
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In news that will worry the Bank of England and the Treasury as they try to secure a still-fragile economic recovery and limit fears of inflation, British households say that they expect their living standards to fall sharply – and inflation to jump in the next few months.

However, a leading Bank of England policy-maker has warned that the Bank should not now be tempted to compensate for its past mistakes in underestimating inflation by pushing interest rates up.

Adam Posen, an external member of the Bank's Monetary Policy Committee, said yesterday: "The persistently above-target CPI inflation the UK economy is experiencing is almost entirely due to the combination of the depreciation of sterling prior to January 2009 and the increase in VAT in January 2010... the MPC should not tighten in response to the inherently temporary effects on measured CPI inflation of a VAT increase."

Mr Posen has consistently argued that the Bank should act again to boost demand in the economy, as public spending cuts make their effects felt on confidence, demand and growth.

It highlights the intense debate both within the Bank and in Government circles about whether the nation might need a "Plan B" if the present combination of fiscal austerity and loose monetary policy fails to work.

Even as the economy slows,consumers believe that inflation will remain relatively high. The Bank of England's latest survey shows a typical expectation of inflation over the next year of 3.9 per cent, up from 3.6 per cent in the August survey. Though higher, the public's outlook is not radically different to that published by the Bank itself, which shows it peaking at around 3.5 per cent next spring, and not returning to the 2 per cent target before spring 2012.

Satisfaction with the way the Bank is controlling price rises is at a net rating of 22 per cent, down from 28 per cent in August. Apart from a few months in 2009, confidence in the Bank has rarely been lower since it gained independence in 1997.

So called "hawks" on the MPC,notably Andrew Sentance, have pointed to inflationary expectations as a reason for the Bank to implement a pre-emptive, though small, rise in rates. Still, many of the public agree with Bank's "no change" stance.

According to the latest Nationwide survey of consumer sentiment, the fall in confidence seen last month was "comparable" to the declines seen in the wake of the Lehman collapse in 2008 – when almost every economic indicator fell off a cliff and ushered in the worst global slump in three-quarters of a century. At a net balance of 45, it stands at its lowest since March 2009, and is close to an all-time low.

The Nationwide's economists warned that a combination of the Irish sovereign debt crisis, talk about public spending cuts and job losses, and fears of unemployment had relatively depressed people's expectations about their personal financial situation over the next six months.

Martin Gahbauer, the Nationwide's chief economist, said: "Despite theapproach of the holiday season, there was a noticeable absence of festive cheer in November."

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