Inflation to hit 5 per cent

The Bank of England Inflation Report, published today, reveals that the governor believes there is still “is a great deal of uncertainty about the outlook for inflation”.

He said: “Although inflation fell to 4% in March, it remains uncomfortably high and well above the 2% target. And there is a good chance that, if utility prices rise further later in the year, inflation will reach 5%, before falling back through 2012 and into 2013.”

King noted that inflation is being pushed up by a range of influences – primarily the past rises in commodity and import prices, as well as the increase in the standard rate of VAT.

He said: “There is a risk that continuing high rates of inflation will push up on inflation expectations, or lead to some resistance to the erosion of real take-home pay.

“Either of these mechanisms could put upward pressure on wages and prices looking ahead, and imply that inflation will not fall back as sharply when the temporary effects of higher VAT, energy and import prices come to an end.”

However King said weak economic growth would act on the downside.

He said: “Four-quarter growth is likely to pick up during 2011, although there could be some further volatility in quarterly growth rates. The most likely outcome for growth in the medium term is somewhat weaker than in the February Report, reflecting a delayed recovery in consumption and a less pronounced boost from net exports.”

“But there are clear downside risks to this view – household spending may have further to adjust to the significant squeeze in real incomes and there is substantial uncertainty over the speed at which net exports will pick up.”

King said the Monetary Policy Committee would have to take both inflation and depressed growth into account when setting the base rate.

He said: “As I have argued before, the MPC needs to look through such short-term [inflation] fluctuations, and focus on the outlook in the medium term. As the economy gradually recovers from a deep recession, and rebalances towards a more sustainable path, the outlook for growth and inflation is likely to remain unusually uncertain.

“Perfectly reasonable differences in judgements regarding the size and nature of the forces affecting the economy can have a material impact on the outlook. No one knows how the economy will evolve over the next few years; nor how policy will need to respond.

“But I can assure you that the Committee is united in its determination to ensure that inflation returns to the 2% target in the medium term.”