Bank Governor issues wages and inflation warning

| January 26, 2011 | 0 Comments

Speaking in Newcastle last night, the Governor of the Bank of England, Mervyn King, said inflation could rise as high as 5% but will fall back to its target by 2012.

Mr King previously dismissed fears that higher inflation would demand a significant rise in interest rates in the months ahead.

The CPI inflation rate is a benchmark for the Bank of England’s Monetary Policy rate-setting Committee but interest rates have now been held at the historic low of 0.5% for almost two years.

Many leading business groups have suggested that inflation could exceed the 4% mark – because of the recent VAT hike.

Last week, official data revealed Consumer Price Inflation (CPI) rose to an annual rate of 3.7% in December, up from 3.3% in November.

The figure was much higher than the 3.4% analysts had expected and inflation has now been above its target of 2% for over a year.

As well as the VAT hike, Mr King attributed rising inflation to higher import prices as a result of the weak pound and higher energy and commodity prices.

Meanwhile, speaking of wages, Mr King said: “In 2011 real wages are likely to be no higher than they were in 2005. One has to go back to the 1920s to find a time when real wages fell over a six year period.”

He explained that if the Bank had tried to control higher prices by raising interest rates, it would have led to falling wages - and therefore the same loss in spending power.

“Monetary policy can affect the inflation rate at which these adjustments take place,” he said.

“But it cannot alter the fact that, one way or another, the squeeze in living standards is the inevitable price to pay for the financial crisis and subsequent rebalancing of the world and UK economies.”

His speech came shortly after official data revealed the UK economy contracted by 0.5% in the October to December period.

The figures shocked economists who had expected growth of 0.5%.

Analysts had expected economic growth to slow – in light of the Government’s massive spending cuts – designed to bring down the budget deficit.

However, the results came as a surprise but have been attributed to the poor weather late last year.

Mr King referred to his comments last year when he suggested that the recovery would be “choppy” and the economy will face “headwinds“.

Nevertheless, he described the fourth quarter figures as “disappointing numbers”.

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