UK inflation high for much of next year – BoE governor

Bank of England Governor Mervyn King yesterday warned inflation would remain high throughout most of 2011 in a further blow to households facing rising costs and tough austerity measures.

Mr King told MPs on the Treasury Select Committee that Consumer Prices Index inflation had been high for most of the past four years and would likely stay above the government’s two per cent target for “much of next year”.

He cautioned it would be “difficult to bring inflation back down again” if high CPI expectations became ingrained.

The Bank’s rate-setters are charged with keeping inflation at two per cent but the Consumer Prices Index benchmark has been above three per cent throughout the year.

And despite “encouraging” 1.1 per cent growth for the economy in the second quarter, the governor warned that we “cannot be confident” the recovery will be sustained, raising the spectre of “stagflation” – high inflation and stuttering growth.

Mr King said interest rates would eventually return to “more normal” levels, but added: “I fear there is some significant distance to travel before we can begin to use the word ‘normal’.”

The governor was also pressed by committee chairman Andrew Tyrie on whether Chancellor George Osborne’s emergency Budget had increased the chances of a return to recession.

“I don’t think it made a significant difference to whether we get what is technically known as a ‘double-dip’ recession,” he said.

MPs questioned whether the Bank was doing enough to help encourage lending to small businesses to aid the recovery.

One committee member said: “Are you waiting for the market to sort it, or is there anything you should be doing to get it going?”

The central bank boss said there was little the bank could do, as the banking sector was struggling to meet higher requirements on capital strength imposed in the wake of the financial crisis.

But he sent out a warning shot to banks ahead of next week’s start of the half-year reporting season, saying they should put capital strength ahead of bonuses and dividends.

“It would be better for all concerned if there was less emphasis on distribution, whether in compensation or dividends, and more on building up their balance sheets,” he said.

State-owned banks were also not being used to their greatest effect to increase lending levels, according to Mr King.

He said their government-set lending targets were unlikely to be effective, given that they focused on gross lending rather than net, where repayments are also taken into account.

Mr King insisted new competition in the bank sector was vital to see lending increased.

And the barriers to entry should be eased to encourage new players to enter the market, he said.

Metro Bank, one of the first new high street banks to launch in the UK for decades, opens its doors for the first time today.

But the flurry of competition expected after the financial crisis has failed to materialise, leading to calls for regulations to be eased to smooth the way.

The cross-party committee recently announced the launch earlier this month of an inquiry into competition in the sector.

Mr King said: “If there are impediments in the regulatory system then we need to find a way through it so new banks can get going.”

The Governor reiterated his support for the government’s Budget measures to reduce the deficit and similar actions across Europe.

He also suggested the US has been wrong to prioritise growth over cutting debt levels.

“All countries need to have a credible medium term plan within which they can demonstrate that they will get back to a position in which structural deficits are eliminated and there is a sustainable path for the long-term public finances,” he said.

“Not spelling it out is, I think, a problem.” The Bank said austerity measures were part of a painful rebalancing of economies towards the private sector.

“I think we are are in for a long haul,” said Mr King.

The MPC stands ready to raise rates to rein in inflation in the UK, but today’s comments from Mr King signals the Bank remains more concerned over the sustainability of the recovery.

He added that when the MPC feels it is right to tighten monetary policy, rates would be raised before an orderly unwinding of its £200 billion quantitative easing programme.