Monday 13 June 2011

Bank of England: No need to raise interest rate as low wages are slowing down inflation


Interest rates do not need to rise despite surging inflation, the Bank of England says.
A study by the Bank published today suggests that rates can be safely held at 0.5 per cent in order to prevent growth from stalling.
It shows that while energy and food costs are soaring, there is little evidence that short-term price rises are feeding through to wages or long-term price setting by big companies.
This eases fears that consumer price inflation will continue to run at more than twice the Treasury’s 2 per cent target. There is widespread concern that Britain is heading for a period of ‘stagflation’ – when prices rise as the economy stagnates.

But the Bank says today in its influential Quarterly Bulletin that ‘long term inflationary expectations remain anchored by the monetary framework’, which is sure to be a relief to Chancellor George Osborne. 
There has been widespread concern in Whitehall that rising inflation, as a result of the boom in commodity and oil prices, could throw Mr Osborne’s austere economic policy off course.

Sir Mervyn King, the Bank’s newly-knighted governor, has repeatedly promised to keep rates low to allow public spending to be cut without destroying the recovery. If the Bank were to start raising interest rates at this stage in the recovery it could put a further brake on lacklustre consumer spending and investment by industry. 
Individual and corporate spending are seen as key to keeping the economy expanding at a time when the cuts – taking £80billion out of the public sector over the next four years – are just taking hold.
Figures released by the National Institute for Social and Economic Research last week suggest that the economy grew 0.4 per cent in the three months to the end of May. 
In today’s report, the Bank says ‘there are few signs that inflationary expectations have affected price or wage setting behaviour’ because the firms, individuals and markets that it examined all seemed sure that inflation will start to return to the 2 per cent target level, from the current 4.5 per cent, by early in 2012.
Over the past three years inflation, as measured by the consumer prices index (CPI), has frequently been one percentage point above the 2 per cent target. 




Despite this longer term interest rates – the market cost of borrowing for British mortgage lenders, banks and corporations – have actually been falling. 
This is in sharp contrast to what has been happening in troubled Euro-zone countries.
‘In the UK this largely reflected a decline in inflation towards the end of the period,’ the Bank’s experts say.
The Bank has found little evidence that recent rises in the CPI have any impact on wage settlements. 
It reports that ‘current wage growth remains around 2 per cent, some way below its pre-recession average rate’. 
With wages frozen in the public sector and unemployment stubborn in the private sector, the Bank argues that ‘there are few signs that households are pushing for higher pay


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