Bank fears over inflation rises remain

Jan 28 2010 By The Journal

THE UK should avoid a dreaded "double-dip" recession but fears over inflation remain, according to a Bank of England interest rate-setter.

Monetary Policy Committee (MPC) member Andrew Sentance said the weaker pound and a "reasonably robust" world economy should offset the impact of a struggling banking sector and looming action to tackle the UK budget deficit.

Speaking a day after a weak 0.1% return to growth was confirmed, he said: "As long as the international economy continues to grow healthily, I believe we should avoid the feared "double-dip" recession."

But he added the pace of recovery would remain "uncertain" and hinted at early action to hike rates from record lows to prevent inflation getting out of control.

Mr Sentance – one of the MPC’s rate "hawks" – said that inflation has been above the Bank’s 2% target for most of the past three years.

The UK can no longer rely on the "China effect" of cheap imported goods to hold down prices due to the recent fall in the value of the pound, he warned. Rising import costs are keeping inflation above target despite the slump in output, while unemployment is lower than expected – meaning there could be less slack in the labour market to bring down prices.

If the tailwinds from international recovery and a weaker exchange rate overcome the hurdles presented by the legacy of the financial crisis and a programme of spending cuts, there could be upward pressure on inflation, he warned.

"Which of these scenarios unfolds will have a critical bearing on the decisions which the MPC must take over the next couple of years – both on the future path of interest rates and on our approach to quantitative easing," he said.

Mr Sentance added that there is "scope for a much stronger recovery" in house prices over the coming years as pressures on lenders ease.

Housing investment has fallen to a "historically low" level as builders cut back in the early stages of the slump, underpinning demand, he said.

"The underlying forces – in terms of the balance of demand and supply – are likely to be more positive for house prices and investment than in the last recovery in the early 1990s, which may help to account for the bounce in house prices we have seen over the last year," added Mr Sentance.