–Adds Detail To Version Transmitted At 1426 GMT
–Not Difficult To Understand Why CPI Above Target
–QE Could Be Deployed If Necessary

LONDON (MNI) – The Monetary Policy Committee is concerned that
inflation has been running above the committee’s 2.0% target, although
it is not difficult to explain why it has, Bank of England Governor
Mervyn King said in evidence to the House of Lords Economic Affairs
Committee Tuesday.

King was questioned about the MPC’s failure to predict the strength
of inflation, but he argued the BOE’s forecasts should not be thought of
as spot predictions. King, speaking after the latest data showed CPI
came in at 3.2% in October, said the worry was that elevated inflation
would feed through into higher inflation expectations.

“It is important not to think of forecasts as point estimates – as
“spot the ball” estimates where you are trying to guess the precise
number,” King said.

“It is of concern to us that inflation is above the target, has
been so for a number of months in the past three years but I don’t think
it is difficult to understand why,” he added.

“In fact there are many explanations that one could appeal to as to
why inflation is currently above target,” King said.

“We have seen significant increases in energy and commodity prices,
we saw VAT go up in January of this year, it is due to go up again in
January of next year and, of course, perhaps most important of all, the
effective exchange rate for sterling has, on average, fallen by 25% from
the period in the middle of 2007 to the end of 2007,” the BOE head said.

King said a fall of this scale for sterling would “in and of itself
add about 6 percentage points to the price level which, spread across
say three years, would be roughly 2 percentage points on the inflation
rate.”

“In the medium term we would certainly hope and expect to bring
inflation back to as close as we can to the target. In the short run,
the real question is why has it been above target and I don’t think it
is difficult to understand why,” he said.

The BOE governor argued it would be a mistake to use monetary
policy to try and offset short-term inflationary effects.

“In the short run if there are movements in imported costs or
indeed, in some cases, domestic costs and the change in the rate of
value-added tax, it may be very costly to try to offset that in the
short-run,” King said.

He stressed, however, that the concern was the impact elevated
inflation would have on expectations and if this risk materialized the
MPC may have to act.

“If inflation expectations are well-above target, and de-anchored
then it may be necessary to adopt difficult and painful policies to
bring those expectations down,” he said

“That was the challenge that we faced in the past… at present
that isn’t the case,” he added.

“I think that if you look to imported costs, you can certainly see
in the past six months, if you look at the changes since the summer, oil
prices are up are 15%, metal prices are 25% up, food prices up to 35%,
these are big shocks that will have an effect on the price level,” King
said.

While the near term picture is one of elevated inflation, in the
medium inflation should fall back to target, according to the majority
on the MPC.

“Looking further ahead, say 2-3 years ahead, which is what I meant
by the medium term, I think other factors come into play… consistent
with inflation being well under control,” King said.

“If you look at what’s happening to broad money growth, that was
rising at 10% a year for much of the past decade, now it’s rising at one
or two percent a year… If you look at money wage growth it’s only
growing by around 2% a year, well below the level we think would
normally be consistent with meeting the inflation target,” King said.

“It’s very hard to know how much spare capacity there is in the
economy, but that there is spare capacity, I don’t think is a
particularly controversial statement,” he added.

King said it was “a reasonable view and judgement (that) the
medium-term factors driving inflation are all pointing in the same
direction, which is inflation consistent with target.”

He said that while there were upside inflation risks, there were
also substantial downside ones.

“There is a significant risk of inflation undershooting the target,
these things have to be balanced. I accept that there is no unique
answer to that question of where you strike that balance,” King said.

The BOE Governor insisted that quantitative easing remained a
viable policy instrument if needed.

“We could do further quantitative easing if that turns out to be
necessary. Further asset purchases – we see that as a normal instrument
of monetary policy. It has a long pedigree in the past. What is unusual
is not the nature of the instrument but the circumstances in which we’re
deploying it… It is an instrument that could be deployed if
necessary,” he said.

Unsurprising Opinions Divided On MPC

The MPC has split three ways over policy. At its October meeting,
Adam Posen voted for more quantitative easing, while Andrew Sentance
voted for a 25 basis point rate hike, with every other MPC member
backing unchanged policy.

King said MPC members did agree on the big picture “which is we had
a large shock to the economy, there is spare capacity, a rebalancing is
needed, there do seem to be signs of export demand picking up and we
have a fiscal consolidation coming down the road.”

The cause of disagreement is “what is the precise quantitative
impact of all this on the outlook for inflation.”

“There are some differences on the committee … I don’t think,
given the scale of shocks we are confronting, it is particularly
surprising, as they are very large.”

The minutes for the November meeting of the MPC come out Wednesday
and King said when they are published “you will see the different views
on the committee.”

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

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