Consumers should expect rising prices to lead to a squeeze on their take-home pay for the foreseeable future, the Bank of England has warned, as high inflation shows no sign of abating.
The central bank’s quarterly inflation report, published today, admits that the outlook for inflations has “deteriorated markedly” over the past three months, with the Consumer Price Index (CPI) hitting 4.4% in July.
Rising wholesale energy prices (impacting on household bills, petrol and other transport costs) as well as soaring food prices are largely to blame for the rise in inflation. The governor of the Bank of England says that as a result, consumers should expect to see a larger chunk of their take-home spent on essentials. He also predicts a slowdown in consumer spending, and an improvement in people’s saving habits.
The governor, Mervyn King, says the UK economy is undergoing a rebalance, away from spending and importing, towards saving and exporting.
The report, one of the gloomiest seen, offers a dim view of the near-term future. In it, King forecasts a sharp fall in economic growth in the short-term, as people cut back on spending, and refuses to rule out a recession hitting UK shores.
He also predicts that, for “several quarters”, inflation will remain about the 3% mark, and high energy costs continue to push up overall prices.
It is also unclear whether interest rates will be cut to help bolster the faltering economy, or indeed increase to help calm inflation.
Economists are largely expecting rates to remain frozen for the rest of 2008, with cuts early next year.
However, in the report, King hints that this may not be the case: “The Monetary Policy Committee (MPC) is aiming to bring inflation back to target over a somewhat longer horizon. That does not, however, mean it is ignoring the near-term rise in inflation.
“The extent of the deviation from target this year is likely to affect the behaviour of those setting prices and wages. For that reason, the MPC judges that a slowing of demand growth this year, reducing pressure on capacity, will be necessary to ensure that inflation settles around the target in the medium term.”
Inflation soared to an alarming 4.4% in July - up from 3.8% the previous month, reflecting the rising cost of food and petrol.
The government’s target for CPI – the official measure of inflation – is 2%. When inflation rises to more than 100 basis points above this target, the Bank of England’s governor Mervyn King is required to write to Alistair Darling to explain the reasons and outline how inflation will be tackled.
The CPI is now at its highest since April 1992, with July's increase the biggest since records began.