Bank of England's governor predicts sharp decline in inflation

By Scheherazade Daneshkhu
Financial Times, London
Tuesday, April 24, 2007

http://www.ft.com/cms/s/7a553420-f289-11db-a454-000b5df10621.html

Inflation will fall soon, Mervyn King, the Bank of England governor, forecast on Tuesday as he rejected charges that the Bank had underestimated the problem.

"We are completely determined to bring inflation back to target," said Mr King, appearing before the House of Commons Treasury committee to give evidence on 10 years of Bank of England independence.

Consumer price inflation reached a record high of 3.1 per cent last month, triggering the governor's first open letter of explanation to the chancellor, Gordon Brown.

Mr King told the MPs he expected the Consumer Price Index to fall back. "This could be a sharp fall back over the next four to six months," he said. Previously, he has pointed to unusually low UK inflation over the past decade, saying economic conditions are likely to become more difficult.

He denied that the deviation of more than 1 percentage point from the official 2 percent inflation target amounted to a policy failure, noting, "Most measures of inflation expectations are close to target."

The Bank has raised interest rates by a quarter of a percentage point three times since August to 5.25 percent, and most economists expect another rise to 5.5 percent next month, with the risk of a 0.5-point rise. Some economists think rates may go up again later this year.

The Bank's fear about price pressures emanating from firms looking to rebuild profit margins was highlighted on Tuesday when a CBI survey indicated that manufacturers were able to push through price rises as demand for goods remained robust, despite the strengthening pound. The quarterly industrial trends showed business confidence in the sector at a three-year high and growth in new orders stronger than at any time in the past decade -- apart from a brief period in 2004.

Mr King responded to a letter from Tim Congdon and other economists published in Tuesday's Financial Times, which said the Bank had underestimated the threat of inflation partly because it did not place enough emphasis on money supply figures when making decisions on interest rates. The governor said there was a link between money supply growth and inflation but it was difficult to measure. While agreeing that "inflation is made at home," he said UK house and other asset prices had been driven up by low property rates worldwide.

"In a global capital market where money can move freely, what determines asset prices in the UK is very much what is happening in the world market.

"And in the past few years there's been a real sharp fall in risk premium around the world and that has driven up asset prices," he said. On appointments to the monetary policy committee, he saw no problem in openly advertising the four external expert posts, while keeping applicants' names secret.

He repeated a call for the appointments to be made in a "timely" fashion. He criticised Mr Brown last year for a "very informal" approach to choosing MPC members. Mr Brown has been accused of operating an overly secretive appointments system, but has resisted changing it, citing market sensitivity.

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