–UK Economy Shows No Signs Indicating Sustained Inflation
–Likely, Not Certain, Spare Capacity Will Bear Down On Inflation
–Bank Rate Will Likely Be Active Instrument To Tighten Policy

LONDON (MNI) – The Bank of England’s Monetary Policy Committee
won’t hesitate to withdraw monetary stimulus when necessary, but the UK
economy has none of the traits associated with continuously rising
prices and policy must be set in light of fiscal tightening and
financial market fragility, Governor Mervyn King said Wednesday.

In his annual Mansion House speech King defended the MPC against
the charge it is no longer committed to low and stable inflation, with
CPI recently coming in well above the BOE’s 2.0% target. He argued the
economic fundamentals do not support persistent price rises, and
highlighted the one-off factors that have driven CPI higher.

“A continuous rise in prices would ordinarily be associated with
strong money growth, wage inflation, rapid increases in money spending
and an excess of demand over the supply capacity of the economy. The UK
economy exhibits none of these traits,” King said.

Growth rates in broad money, pay and spending are all
“significantly lower than the average growth rates recorded before the
crisis” and there is plenty of evidence of spare capacity in the
economy.

The impact of value added tax changes and sterling depreciation
have had a significant impact in driving inflation higher, and King
restated the MPC’s belief spare capacity is likely to press down on
inflation ahead.

King said the MPC members were well aware there were risks both to
the upside and downside and it would be foolish to ignore them.

On the upside “the apparent rise in inflation expectations is one
that concerns us. We have always explicitly recognised that there is a
significant chance that inflation may turn out to be above target,” he
said.

“What the MPC must do is continually update its assessment of those
risks, and set policy in order that, on balance, inflation remains on
track to meet the target in the medium term,” King said.

He said when the time came for the MPC to manage the withdrawal
from the exceptional monetary stimulus it has put in place it would not
hesitate to do so. Tightening would most likely come through a rise in
Bank Rate, with sales of the assets the BOE has bought being “conducted
later in an orderly programme over time.”

This entails Bank Rate will be the active instrument in monetary
policy, rather than asset sales.

While the MPC won’t hesitate to tighten when the time is right,
King said it must factor in the headwinds facing the economy at present.

“Monetary policy must be set in the light of the fiscal
tightening over the coming years, the continuing fragility in financial
markets and the state of the banking system,” the BOE Governor said.

King also welcomed the government’s commitment to fiscal
tightening, saying it cannot be delayed.

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

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