Inflation to stay above target, says Bank of England

Sir Mervyn King: "Inflation is likely to rise in the near term"

The UK inflation rate will remain stubbornly high for longer than previously thought, the governor of the Bank of England has said.

Sir Mervyn King now expects inflation, currently 2.7%, to rise to at least 3% by the summer and to remain above the Bank's 2% target for two years.

In November he had said that inflation would fall back towards its target in the second half of this year.

But the governor also said that "a recovery is in sight".

Sir Mervyn King, presenting the Bank's latest Quarterly Inflation Report, 20 years after it issued its first one, said the economy had "cause for optimism".

'Own goal'

Sir Mervyn said that factors outside of the Bank's control - increases in university tuition fees and utility bills - had added to inflation recently.

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Inflation is going to stay further above target, for longer. And the Bank of England is not planning to do much about it. Growth in the real economy is also going to continue to disappoint. And our central bank doesn't expect to make a big difference to that either”

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"If you like, it is a bit of a self-inflicted goal in terms of the damage done to real take-home pay, perhaps another way of trying to implement fiscal consolidation through moving up the price level," he said.

"This is not the result of easy monetary policy and nor does it reflect what's going on in the economy."

He drew parallels between now and when the Bank's first inflation report was presented in 1993.

"[In February 1993] unemployment had just reached its peak. Although we didn't know it at the time a recovery was on its way.

"[Today] there is cause for optimism. Today too a recovery is in sight."

'Encouraging' picture

The economy shrank by 0.3% in the last three months of 2012, fuelling fears that the UK could re-enter recession, defined as two consecutive quarters of contraction.

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The Bank remains between a rock and a hard place in trying to strike a balance between the rising pressures of inflation and supporting the economic recovery”

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Although economic output has been broadly flat for the past two years, Sir Mervyn said that masked "a more encouraging underlying picture".

Manufacturing and services - which make up the bulk of the economy - had grown during 2012, seeing a similar performance to that in the US and considerably stronger than in Japan and the eurozone, he said.

The weakness in overall output reflected falls in construction, which is "unlikely to be repeated in 2013".

"This hasn't been a normal recession and it won't be a normal recovery," he said.

"Growth is likely to be weak in the near term but further out a continued easing in domestic credit conditions, supported by the Bank's asset purchase programme and the Funding for Lending Scheme, together with the stronger global backdrop, underpin a slow but steady recovery in output," the governor said.

Attempting to bring inflation back to target sooner would risk "derailing the recovery", he added.

Joshua Raymond, chief market strategist at City Index, said the report showed "a continuing divorce of priorities at the Bank of England from inflation targeting to supporting the economic recovery".

"The Bank remains between a rock and a hard place in trying to strike a balance between the rising pressures of inflation and supporting the economic recovery," he said.

"Clearly right now the Bank is firmly weighting its actions to the latter at the expense of inflation but the question is how long can this last?"

Living standards

Sir Mervyn was delivering his penultimate Inflation Report. His last Report will be in May, before he is replaced by Mark Carney as governor in the summer.

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The governor's message that the central bank was resigned to above-target inflation sent the pound falling on the currency markets.

It fell 1% against the euro to 1.1521 euros and was 0.6% lower against the dollar at $1.5573.

The prospects for inflation will be a blow for many facing pay freezes or below-inflation wage rises.

The Office for National Statistics said on Wednesday that UK workers were earning no more than they were 10 years ago, while a report from the Resolution Foundation think tank warned that it could be another 10 years before living standards return to the levels they were at before the recession.

In Prime Minister's Questions, Labour leader Ed Miliband asked David Cameron if living standards would be higher in 2015 than they were in 2010.

The prime minister said that people on the minimum wage would be better off due to cuts in income tax bills, and pointed out that inflation is lower now than it was in 2010.

"People will be a lot better off than they were under Labour, with a record deficit, with unreformed welfare, with a busted banking system," Mr Cameron said.

"They will have seen a government that's got the deficit down, that's cut their income taxes, that's dealt with the banks."

Labour's shadow chancellor took a different view: "Our flatlining economy means wages and living standards are being squeezed and ministers are piling on top of that cuts to tax credits and child benefit while giving millionaires an average £100,000 tax cut in April," said Ed Balls.

He accused the prime minister and chancellor of being "totally out of touch with millions of working people".

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