Bank of England's newest member of rate setting committee says recent slump in UK growth could be a one-off
Interest rates need to rise quickly to combat inflation, which is expected to rise to 5% in the next few months, according to the newest member of the Bank of England's rate setting committee.
Martin Weale, who has written in the Guardian his first analysis of the economy since joining the monetary policy committee, said the recent slump in the UK's growth could be a one-off and should not deflect the committee from tackling inflation with higher rates.
Weale shocked the City and many of his fellow economists when he voted with fellow committee member Andrew Sentence for a rate rise. They argued for a 0.5% increase to 1% to prevent inflation getting above its current 3.7% level. Five members, including Bank of England governor Mervyn King voted for no change and one, Adam Posen, voted to keep interest rates low for several years.
Weale and Sentence fear that persistently high inflation will encourage demands for higher wages. They said businesses were also exploiting the perception that costs were due to rise by jacking up prices by more than inflation.
Weale's hawkish intervention poses a dilemma for the chancellor George Osborne, who has relied on the Bank of England maintaining low rates while he imposes steep public sector spending cuts.
A majority of Britain's 12 million mortgage holders have tracker or discount rate loans that will increase with rises in bank base rates. They are already under pressure from falling real incomes, and while they have enjoyed historically low rates for the last two years, face a fall in living standards this year that higher mortgage charges will make worse.
Key data this week will give policy makers a first taste of the economy's strength since the end of last year when official figures showed it had contracted 0.5%. Figures on the strength of the services sector, which accounts for some 70% of the economy, are published on Thursday.
King said last week that the falls in real earnings over the last five years had not been seen since the 1920s.
He said families will see their disposable income eaten up as they "pay the inevitable price" for the financial crisis. But he argued inflation was a short-term problem and would fade in importance next year once recent oil price and tax rises, and the VAT rise to 20% in particular, work their way through the figures.
King has become a key ally of Osborne's in convincing the electorate that it must accept high inflation, falling real incomes, higher taxes and cuts in public spending as the price of recovery. King said it was inevitable Britain would struggle to emerge from recession after the worst banking crisis for 70 years.
Weale said: "Much of the increase in inflation has been a consequence of sterling's depreciation, sharply rising commodity prices, and increased VAT. Unlike the experience of earlier decades, it has not been generated by rises in domestic costs. Given the potential consequences for the real economy of attempting to return inflation to the target rapidly, there is therefore a powerful argument that such 'one-off' influences on the inflation rate should simply be accommodated and inflation allowed to rise temporarily above the target ? just as it might fall below target if the exchange rate rose sharply as in the late 1990s. This is consistent with the MPC's mandate."
But he added: "A major risk is that the longer inflation remains above target and the more it exceeds its target, the greater the adverse effects on output of bringing it down. Each month's MPC decision needs to be made on its own merits, but this risk is a substantial one that I will continue to balance against others over the coming months."
Source: http://www.guardian.co.uk/business/2011/jan/30/inflation-interest-rate-rise-economist
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