Inflation breaches the Government’s target – Mervyn King writes letter to explain why

For the first time since it was granted independence in 1997, the Bank of England’s Monetary Policy Committee has had to write an open letter to the Chancellor explaining why inflation has breached the government’s target. CPI inflation rose by 3.1% year-on-year in March, more than 1% away from the 2% level. This was up from 2.8% in February. The drivers of this unexpected increase were food, non-alcoholic drinks, furniture and household goods. The RPI print was even higher, at 4.8%, thanks to rising house prices and mortgage interest payments which are not included in the CPI target. Fortunately the bulk of this year’s pay round – which tends to focus on RPI as a benchmark – has already gone though, at modest levels of increases. Nevertheless today’s numbers make further UK rate rises a certainty, and short dated gilts have sold off heavily this morning.
You can read Governor Mervyn King’s letter to the Chancellor here, and Gordon Brown’s response here. In brief, King states that inflation is higher than expected due to domestic energy price hikes, and a weather related global food price hike. However he states that this only explains around half of the problem and that money and credit growth are growing too strongly, and capacity issues are growing – these, to some extent, were within his remit to control, whereas the oil and food prices issues were external shocks. So is he admitting that he should have set tighter policy? No – he talks a lot about lags in policy setting, and about unforeseen volatility in the inflation numbers, as well as other temporary factors. In particular he expects household gas and electricity prices to fall back later this year, bringing inflation back within target. He says that the MPC will assess these inflation numbers at its May meeting (flagging a hike then). His final quote is probably quite reasonable – “when the MPC was set up in 1997, the chances of going almost ten years without an open letter beig triggered seemed negligible”. And the Bank has done a good job – but whereas inflation was consistently below the government’s target in the first half of the decade since independence (under Lord George), it has been stubbonly above it in more recent years.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Jim Leaviss

Blast from the Past logo Blast from the Past logo

16 years of comment

Discover historical blogs from our extensive archive with our Blast from the past feature. View the most popular blogs posted this month - 5, 10 or 15 years ago!

Next Blogs