Bank Governor Warns
May 11, 2011Mervyn King has warned that higher fuel prices will push inflation to 5% before the end of the year. Normally this should be alarming news and, as this blog as often argued, presage a rise in interest rates. That is not going to happen, because higher interest rates would mean a stronger pound. The industrial recovery, geared to exports, would find a higher pound much more difficult than a marginal hike in borrowing costs.
This reveals a weakness in the current model of inflation management. Interest could have been used at the start of the cycle, but the opportunity was missed. By letting interest stagnate while inflation rose on a falling pound, the value of sterling debt was reduced. The benefit of this is, however, lost against the rise in value of overseas debt, measured mostly in dollars and which is very large.
The problem now for the MPC is that even if inflation is not out of control, yet, it is out of the MPC’s control, because it cannot use the only weapon it has in the curent climate. It still believes everything will come right in the end. We must all hope so.
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