Bank dashes hope of interest rate cut

Bank dashes hope of interest rate cut

Mervyn King last night dashed hopes of cuts in interest rates to boost growth when he admitted that the economy would have to slow markedly this year to bring inflation back under control.

Despite recognising that there was a danger of the UK suffering a "quarter or two" of falling output, the Bank of England governor said the economy faced an inevitable period of adjustment after its credit-fuelled excesses of recent years.

King said that, with inflation on course to rise above 3.5% over the coming months, compared with a target of 2%, he would be forced to write a series of letters to the chancellor, Alistair Darling, explaining the Bank's failure to meet its mandate. Under the terms of the Bank's independence, the governor has to write a letter once a quarter if inflation deviates more than a percentage point from its target.

Inflation as measured by the consumer prices index (CPI) stands at 3.0%, but the Bank believes rising food prices, oil at $125 a barrel and a falling pound mean that the cost of living will continue to rise. King said there was a concern at the Bank that higher inflation could become entrenched, with workers seeking compensation for rising prices through higher wages and companies attempting to pass on cost increases to their customers.

Launching the Bank's quarterly overview of the economy, King said that the nine-strong monetary policy committee that sets interest rates faced its most difficult challenge yet......continued below

Advertisement starts

---

---

Advertisement ends

"Commodity prices are rising. We are travelling along a bumpy road as the economy rebalances. Monetary policy cannot, and should not try to, prevent that adjustment".

Amid clear signs that the economy is slowing, King said bringing inflation back to its 2% target within the next 12 months would inflict too much pain, adding that the MPC was already expecting growth to slow sharply to around 1% later this year. A slowing of demand growth would be needed to reduce pressure on capacity and thus ensure that over time inflation came back to its target.

But the Bank's Inflation Report said that inflation and growth risks had grown since it released its last assessment in February. "Overall, the risks around the central projection to growth lie to the downside in the medium term, while those to inflation are to the upside."

Peter Dixon, UK economist at Commerzbank, said he did not expect any further reduction in the cost of borrowing until November since it would be tactically difficult for the MPC to cut while inflation was so high.

Michael Saunders, of Citgroup, said he had changed his view about the timing of interest rate cuts as a result of the Inflation Report. "We still expect the MPC will cut rates by a percentage point or so, but, as inflation expectations surge and the near-term inflation spike climbs ever higher, we now expect that easing will be delayed."

guardian.co.uk © Guardian Newspapers Limited 2008