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We clearly have an 'inflation problem'

Andrew Neil | 10:28 UK time, Tuesday, 15 February 2011

Mervyn King

Mervyn King had to get out his impressive Bank of England headed notepaper this morning and write a letter to the Chancellor explaining why the Consumer Price Index (CPI) hit 4% in January -- 100% higher than the 2% inflation target the Bank is meant to hit.

I suspect it won't be long before interest rates come down the pike.

The Treasury is getting used to these little billet doux from the Governor -- last year Mr King had to write three of them. The Bank will no doubt stick to its line that it's really all a blip and that inflation will soon fall back. But even core inflation (stripping out short-term factors) is at 3% (50% higher than the Bank's target).

Mr King has had to concede that the CPI will stay at between 4 and 5% for the rest of the year ie it will get worse in 2011 before it gets better. The Retail Price Index (RPI), which includes housing costs and is seen as a better guide to rising prices for the average consumer, already hit 5.1% in January.

The usual suspects -- rising oil, commodity and food prices, the increase in Vat -- are being blamed. But (bar the Vat rise) all major economies are being battered by these trends. Yet compared with the US or the Eurozone, UK inflation is distinctly higher. Unlike our major competitors we clearly have an "inflation problem".

It will become more of a problem if these price rises are reflected in wage settlements, in which case inflation will become entrenched and the Governor's blip theory will be in shreds. There's a tight pay policy in the public sector -- but that will test the government's will if it leads to widespread strikes. Private sector pay rises are still muted. But big companies are flush with cash and might decide to meet pay demands rather than endure industrial disruption.

Mr King's reputation and credibility is on the line here, not just in Britain but abroad too. The New York Times Business Section recently published a less than complimentary analysis of his record. Meanwhile, back in Blighty, living standards are about to be squeezed even tighter, which means consumer spending is hardly likely to lead the recovery.

Oh yes, and the markets are pricing in a quarter-point rate rise by May, and at least one more by the end of the year.


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