High inflation forces King to explain again

 
Tim Wallace
Follow Tim
BANK of England governor Mervyn King has been forced to write his ninth consecutive letter to the chancellor to explain why inflation is still so far above its two per cent target.

Inflation fell to 3.6 per cent on the consumer price index (CPI) in January, the Office for National Statistics revealed yesterday – down from 4.2 per cent in December and 5.2 per cent in September, largely thanks to last year’s VAT rise falling out of the figures.

Items like alcoholic drinks, meals in restaurants, cars and fuel all increased much more slowly than last year because of the VAT effect, dragging down the headline rate of inflation.

The cost of living, measured on the retail price index (RPI), fell from 4.8 per cent to 3.9 per cent, and the tax and price index (TPI) fell from 4.5 per cent to 3.6 per cent.

However, even though CPI inflation is at its lowest rate since November 2010, it is still well above its two per cent target, forcing King to send the 14th letter of his time at the head of the Monetary Policy Committee.

He said the VAT rise and jumps in commodities prices, blamed for high inflation in previous months, had now largely fallen out of the calculation, and that the Bank of England expects inflation to drop to two per cent by the end of the year.

Economists took the forecast of lower inflation as a hint that more quantitative easing may be on the way in May, once the current £50bn of gilt purchases has been completed.

The letter also stressed “there is a limit to what monetary policy can achieve when real adjustments are required,” continuing King’s arguments from recent speeches that banks should retain earnings to bolster balance sheets and the government should implement supply side reforms to raise future output as debt is still too high relative to GDP.