King: Energy prices could push inflation to 5%

11 May 2011 11:54 am | By Steve Tolley

Bank of England governor Mervyn King has warned that higher utility bills could push inflation to 5 per cent later in the year and that there continues to be strong downward pressure on GDP growth.

Speaking at the publication of the Bank’s May inflation report, King said that he still expects inflation to fall in 2012 and 2013.

He said: “Although inflation fell to 4 per cent in march, it remains uncomfortably high and well above the 2 per cent target. And there is a good chance that, if utility prices rise further later in the year, inflation will reach 5 per cent before falling back through 2012 and into 2013.”

He said the recent volatility of commodity prices means there is a great deal of uncertainty about the outlook for inflation.

He said the Monetary Policy Committee expects the “recent softness” in GDP figures, which have effectively been flat over the past two quarters, to be temporary but that a squeeze on household income may undermine possible driving forces behind a future recovery.

A GDP fan chart in the report (left) predicting possible future growth based on interest rates staying at 0.5 per cent has shaded slightly down compared to February’s report with the bank cutting its growth forecast for 2011 from 2 per cent in February’s report to 1.7 per cent.

He said: “A recovery in output is likely to be driven by a continuing rise in business investment and a positive contribution from net exports. But there are clear downside risks to this view - household spending may have further to adjust to the significant squeeze in real incomes and there is substantial uncertainty over the speed at which net exports will pick up.”

He added that over 2011 GDP growth is expected to improve but that there could be further volatility along the way.

King reiterated his argument that the MPC needs to “look through” what he described to the Treasury select committee in December last year as “temporary shocks” and instead look toward the medium term, adding that low financial activity in the UK is restraining domestic inflationary pressures.

Cheviot Asset Management partner David Miller says: “By the end of 2011 factors such as VAT rises and petrol prices rises, which account for around 2 per cent of the current inflation rate, will start to fall out of the inflation number. The bottom line is that the components for persistently high inflation are absent and we expect a moderation in inflation concerns as the year progresses.”

However last month, in his last speech as an MPC external member, Andrew Sentence said the “inaction” of the committee to address rising inflation could already have hit its credibility.

If you enjoyed this article, sign up here to receive daily email updates from Money Marketing and Follow @_moneymarketing