Chancellor Alistair Darling has called for restraint on pay rises in the public and private sectors to avoid the risk of rising inflation becoming embedded in the economy.
During his first Mansion House speech, Darling denied reports that higher inflation meant the UK is returning to the days of the 1970s, when inflation rocketed to highs of 26%. But he admitted that steps must be taken now to tackle inflation.
These include avoiding allowing pay to reflect inflation. “Continued restraint on pay is required from both the public and private sector,” Darling said. “To return now to inflationary pay settlements would undermine rather than raise people's living standards with a damaging circle of wage increases eroded by steadily rising prices.”
Darling’s speech comes after the latest Consumer Price Index (CPI) – the official measure of inflation – hit 3.3%, well above the government’s target of 2%. In response to the rise, Bank of England governor Mervyn King was forced to write to Darling to explain the reasons to rising inflation and outlining what measures would be needed to tackle it.
In his letter, King admitted that inflation could hit 4% before the end of the current year. Although he did not rule out interest rate cuts to help the slowing economy, King hinted that these are unlikely to be on the cards anytime soon as inflation remains the central bank’s primary concern.
Some experts have suggested that plans might be afoot in the Treasury to take back some of power for monetary policy the Bank of England was given when Gordon Brown made it independent in 1997. Although any attempt to limit the power of the central bank would seriously undermine its independence – and the government has long considered setting the Bank of England free one of its most momentous economic achievements – some commentators say it is necessary in light of the slowing economy.
But during his Mansion House speech, Darling appeared to rule out any reversal of his predecessor’s decision.
“The government will continue to support the Monetary Policy Committee (MPC) in its decisions to maintain price stability and support the economy."
Speaking ahead of Darling’s Mansion House speech, former shadow chancellor Michael Portillo, called for measures to “conquer inflation”.
He said: “People have forgotten how bad high inflation is. I don’t know if the government will change the law [about monetary policy] or not, but the MPC must do what is needed about interest rates. We have two difficult years ahead but if the MPC fails to tackle inflation that the picture looks much more serious.”
As the CPI figures revealed, rising food and fuel prices - as well as the fall-out from the US credit crunch - are largely to blame to the rise in inflation. Back in the 1970s, pressures on inflation were domestic or home-grown, but today the rise is the result of the global economy of the 21st century.
Mervyn King, also speaking at Mansion House, warned that oil prices are now as high as they were in the 1970s. He added: “Further sharp increases in domestic gas and electricity prices are probably on their way.”
Experts say fuel bills could increase by 40% in 2008 – which will not only hurt households across the UK but will also push up inflation even further.
What the MPC and the Bank of England intend to do about inflation is still hotly debated. The chance of interest rate cuts – or rises – are subject to differing opinion.
King himself said: “Where base rate will ultimately need to move to bring inflation back to target is impossible to judge now.”
Rising prices – but stable wages – equal a difficult time ahead for many households.
King himself notes: “Rising fuel, gas, electricity and food prices mean that average take-home pay will stagnate this year. It will not be an easy time and I know that some families will find it particularly difficult.”