Is Sir Mervyn King too optimistic about the outlook for inflation in the medium term?
15 November 2012 12:18am
The Monetary Policy Committee’s (MPC) projection – that growth will pick up towards 2 per cent in the medium term – seems reasonable, assuming that there are no severe shocks from the Eurozone. But as the recovery becomes more sustained, its view that inflation will fall back to less than 2 per cent by the end of 2014 could prove to be optimistic. This will be especially true if wage growth also picks up from its recent subdued levels, and workers seek to make up for the past squeeze on their real incomes. Additionally, a resumption of stronger growth in China and other emerging markets in 2013-14 could lead to further hikes in global commodity prices. If growth recovers, while inflation remains above target for longer than the MPC expects, there could be a strong case by the end of next year for interest rates to begin to rise.
John Hawksworth is chief economist at PwC.
The rise in near-term inflation is primarily due to temporary factors, such as rising tuition fees and utility prices. The effect of these short-term forces should fade after a year or so. In the medium term, inflation is likely to come under downward pressure from the weakness in activity and the spare capacity that currently exists in Britain’s economy. Further, average earnings growth is just 2 per cent and, with the labour market tentatively weakening, it is likely to stay low. The recent appreciation of sterling will also add to the deflationary pressure by pushing down import prices. Indeed, without further stimulus from the Bank of England, inflation is likely to undershoot its target going further ahead. We expect the Bank of England to initiate another £50bn of quantitative easing in February, and possibly more thereafter.
Victoria Redwood is chief UK economist at Capital Economics.
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