–Defends BOE Policy, Stresses CPI Will Fall Back In 2012
–BOE King: Determinants Suggest Inflation Will Fall Back Quite Sharply
–BOE King: Decision On Hiking Bank Rate Depends On Medium Term Outlook

LONDON (MNI) – Policymakers will not be swayed by adverse publicity
over high inflation and the conditions are still in place for inflation
to fall back quite sharply next year, Bank of England Governor Mervyn
King said in a speech Tuesday.

Recent data have shown inflation, already well above target,
continuing to rise and growth contracting dramatically in the fourth
quarter. But King insisted that the UK was well placed to return to
sustained growth and said policymakers should stick to their current
course.

The BOE governor said Bank Rate would at some stage have to return
to more normal levels from its current historic low of 0.5%. He
stressed, however, that the BOE’s Monetary Policy Committee should make
its decisions in light of the medium term inflation outlook rather be
influenced by what is currently happening to inflation.

“Should Bank Rate rise now? The answer depends on the outlook for
inflation in the medium term,” King said.

While the recent high inflation outturns have generated a lot of
media coverage and led to warnings the central bank could lose
credibility, King said such adverse publicity would not influence
policy.

“The headlines will inevitably focus on the immediate effect of
shocks on CPI inflation rather than the outlook further ahead. Central
banks, though, do not set policy or react according to headlines. They
simply do their work,” he said.

Some pundits have argued the MPC needs to hike Bank Rate to regain
credibility. King, however, said the important thing for the MPC to do
at present is to explain its policy decisions.

“We shall try even harder to explain the basis for policy
decisions. Credibility was not earned in a year, and it will not be lost
in a year. It is the result of experience over a number of years,” he
said.

While highlighting the headwinds facing the UK’s economic recovery,
the BOE governor saw a brighter future as long as policymakers do not
change course.

“The UK economy is well-placed to return to sustained, balanced
growth over the next few years as a result of a fall in the real
exchange rate combined with a credible medium-term path of fiscal
consolidation,” King said.

“Of course, there will be ups and downs as the squalls from the
world economy blow us around. But the right course has been set, and it
is important we maintain it,” he said.

Inflation Could Fall Sharply In 2011

The BOE Governor used a chunk of his speech to explain why
inflation has persistently overshot the 2% CPI target set for the MPC
and he argued that the key determinants for the inflation outlook
suggested it would fall back, possibly quite sharply, next year.

While he conceded that it would reach somewhere between 4 and
5% in the next few months, he made clear that this would not sway the
BOE from its longer-term strategy.

King said there has been almost no domestically generated
inflation, with almost all the rise due to three factors,

Firstly, the sharp increase in import prices, reflecting in part
the fall in sterling. Secondly, the rise in world energy prices and
thirdly the impact of the increases in value added tax.

“Taken together, those three factors by themselves would account
for a remarkable 12% addition to the price level over four years, or an
average increase in the inflation rate of 3 percentage points a year.
Since the consumer price index as a whole rose by not much more, the
contribution of domestically generated inflation over that period was
close to zero,” King said.

King said that even if the MPC had known the increases in energy
and import prices and VAT were coming, tightening policy to offset these
would not have been sensible as it would not have been consistent with
aiming to meet the inflation target in the medium term.

Looking ahead, King said he still believed the most likely scenario
is that inflation, which averaged 3.4% in Q4, will fall back in 2012.

“The volatility of world commodity and energy prices means that
no-one should pretend that short-run movements in inflation are
predictable. But the determinants of inflation further ahead remain
consistent with inflation falling back quite sharply next year,” King
said.

He noted that output was still around 4% below its pre-financial
crisis level and “unemployment remains high and wages are rising
slowly.”

King said broad money growth remained subdued and the UK economy
is behaving, in some ways, in a similar way to the EU and US, where
underlying inflation is below target.

There are, however, also upside risks to inflation from further
increases in commodity and energy prices and the possibility of UK
workers trying to compensate for falling real take-home pay through
wage hikes.

While King noted household surveys had shown rises in inflation
expectations, implied financial market expectations have not risen in
the same way.

More important than expectations is broad money and nominal demand,
King said. And the last remain quiescent. The MPC would respond if wage
negotiators tried to accommodate the rise in commodity and energy prices
in pay deals but so far wages are rising much more slowly than is
normally consistent with meeting the inflation target in the medium
term.

King insisted the MPC has not stopped focussing on the inflation
target and that the era of price stability was not coming to an end.

“I do not believe we are about to return to the days before
independent central banks ushered in a period of price stability. The
Bank of England cannot prevent the squeeze on real take-home pay … But
we can determine our own inflation rate in the long run, whatever
happens in the rest of the world,” he said.

–London newsroom 0044 20 7862 7491; email: drobinson@marketnews.com

[TOPICS: M$B$$$,M$$BE$,MT$$$$]