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Inflation letters may be on way

Bank of England governor Mervyn King has warned of a tough year ahead with rising inflation and further tightening of credit.

Speaking in Bristol last week, King said it is likely that a less buoyant housing market will go hand in hand with slower growth in consumer spending.

He said: “Although there is a considerable stock of equity in owner-occupied housing, with banks tightening the supply of secured and unsecured credit, consumers will find it more difficult to borrow to finance spending.”

King added that tighter credit conditions mean consumers are likely to save more of their income in the next year.

He said in the short term, greater saving will slow economic activity and there is a risk that weaker activity, combined with lower asset prices, could result in further bank losses and a further tightening of credit conditions.

King hinted that interest rates may come down, saying: “We start the year from a position in which bank rate, at 5.5 per cent, is probably bearing down on demand”.

He warned of the inflation threat with higher prices for energy food and imports.

King said: “It is possible that inflation could rise to the level at which I would need to write an open letter of explanation, possibly more than one, to the Chancellor. Although there is little we can do now to avoid some rise in inflation this year, the task of the monetary policy committee is to ensure it is short-lived. If inflation expectations were to pick up in the wake of a rise in inflation this year, then only a more prolonged slowdown would allow inflation to return to target.”

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