“When it is clear that global inflationary pressures, coupled with a substantial decline in the exchange rate and reasonably healthy growth of domestic demand are all contributing to a sustained period of above-target inflation, then the time has come to act,” Sentance said in a speech in London late yesterday.
Inflation accelerated to 3.7 percent in December, exceeding the government’s 3 percent limit for a 10th month. The Monetary Policy Committee still held the key interest rate at a record low of 0.5 percent in January to support growth. Sentance said that officials’ refusal to curtail emergency stimulus may undermine their credibility and stoke further price gains.
“The lack of a substantive policy response” to consumer- price gains “enhances the risk of a loss of credibility in the inflation target itself and a loss of belief in the commitment of the MPC to achieving it,” he said.
The U.K. economy unexpectedly shrank 0.5 percent in the fourth quarter after the coldest December in a century undermined the recovery. Economists in a Bloomberg News survey had forecast a 0.5 percent gain. The Office for National Statistics said growth would probably have been “flattish” without the impact of the weather.
The pound fell as much as 0.9 percent against the dollar after the report and traded at $1.5782 at 11:24 a.m. in London.
The Bank of England has split three ways since October, when Adam Posen said the bank should expand its bond-purchase plan from 200 billion pounds ($316 billion) to prevent inflation from slowing too much once a government spending squeeze takes hold. Posen last week described recent price gains as temporary, indicating he may keep pushing for more stimulus.
Sentance said it’s a “mistake” to view price pressures originating from outside the U.K as temporary, since growth in emerging economies looks set to continue fueling gains in the cost of commodities such as oil. The pound’s drop of about 20 percent on a trade-weighted basis since the start of 2007 is also feeding higher prices in the U.K., he said.
“If we do not start to raise U.K. interest rates gradually soon, we risk having to do so more aggressively in the future -- which could create a big shock to business and consumer confidence further down the track,” Sentance said.
During questions after his speech, Sentance said that the economy can withstand the government’s budget squeeze and that the “drag” on the economy shouldn’t distract the bank from tightening policy to tame inflation.
“Certainly fiscal policy will have some effect on domestic demand -- a drag on domestic demand -- but I think it’s important not to overstate that as long as the world economy remains reasonably healthy and private-sector demand continues to grow,” he said. “I don’t think it’s a show stopper in terms of the need to move monetary policy from what I think is an exceptionally stimulative position to what could still be seen as such a position but not at such a low interest rate.”
Sentance reiterated his call for a “policy of gradually raising rates” and said that it’s not “too late” for the bank to recover credibility on inflation.
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