Hopes for rate cuts dashed as inflation soars
The Bank of England has hinted that it will not cut interest rates again this year as the risk of rising inflation continues to dog efforts to bolster the slowing economy.
In the central bank's quarterly inflation report, Mervyn King, governor of the Bank of England, says the outlook for inflation has "deteriorated markedly" over the past three months. He warns that the Consumer Price Index (CPI) - the government's chosen measure of inflation - could remain well above its 2% target if interest rates are cut by 0.5% this year.
Despite calls for interest rate cuts to help the slowing economy and housing market, it is likely the Bank of England will prioritise keeping a lid on inflation.
King also says: "We are travelling along a bumpy road as the economy rebalances. Monetary policy cannot - and should not - try to prevent that adjustment. The Monetary Policy Committee must focus on bringing inflation back to the 2% target in the medium term."
The latest figures show inflation soared to 3% in April, up from 2.5% in March, driven by high food and fuel costs.
The Inflation Report warns CPI could remain above 3% until well into 2009, and could even spike as high as 3.7%.
If CPI does rise to more than 3%, then King will be forced to put pen to paper and write to chancellor Alistair Darling to explain why inflation has escalated so far above its target.
King has only been required to write to the chancellor on one occasion since the central bank was given independence 11 years ago - in April last year, when inflation hit 3.1%.
The Bank of England's MPC is due to next meet and vote on interest rates on 5 June. Although it cut rates in April and February, it voted to freeze rates at 5% in May. The reasons for the freeze will not be clear until the minutes from May's meeting are published on 21 May, but the risk of rising inflation is likely to have been a key factor.
The Retail Price Index - which includes mortgage repayments - also increased in April to 4.2% from 3.8% in March.
Monetary Policy Committee
A committee designated by the Bank of England to regulate interest rates for the UK. The MPC attempts to keep the economy stable, and maintain the inflation target set by the government and aims to set rates with a view to keeping inflation at a certain level, and avoiding deflation. The MPC meets on the first Thursday of each month and discusses a variety of economics issues and constitutes nine members: the governor, the two deputy governors, the Bank’s chief economist, the executive director for markets and four external members appointed directly by the Chancellor.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The Consumer Price Index is the official measure of inflation adopted by the government to set its target. When commentators refer to changes in inflation, they’re actually referring to the CPI. In the June 2010 Budget, Chancellor announced the government’s intention to also use the CPI for the price indexation of benefits, tax credits and public sector pensions from April 2011. (See also Retail Prices Index).