King Says ‘Severe’ Market Stress Could Threaten U.K.’s Economic Recovery
“Recent developments in world stock markets and in the euro area are of particular concern,” King said in a letter to Chancellor of the Exchequer George Osborne after inflation kept above the central bank’s 3 percent ceiling in data released today. There is a risk of “severe stress and dislocation in financial markets and, were this risk to crystallize, it would have a significant impact on the U.K. economy.”
Inflation accelerated more than economists forecast in July to 4.4 percent, led by the cost of clothes and footwear, housing maintenance and rent. While King predicted that inflation will reach 5 percent in coming months, he said that it might be below 2 percent without the impact of temporary factors such as energy costs and will probably slow through 2012.
“There have been significant movements in financial asset and energy prices since” the last meeting of the Monetary Policy Committee this month, King said. “The committee will continue to monitor those developments closely and will consider their implications for the inflation outlook at its meeting in September.”
King also said that in “responding to those risks, or indeed to other risks in either direction, the MPC can use bank rate or asset purchases to achieve its objective.”
The pound fell as much as 0.4 percent against the dollar before paring its loss after the inflation data were published. It was down 0.1 percent at $1.6374 as of 10:48 a.m. in London. The benchmark 10-year government bond rose, with the yield falling 1 basis point to 2.53 percent.
Even as price pressures intensified, the bank has kept its benchmark interest rate on hold at 0.5 percent to aid a recovery that has shown little sign of gathering momentum. Economic growth slowed to 0.2 percent in the second quarter from 0.5 percent in the previous three months. King said on Aug. 10 that “headwinds” are “becoming stronger by the day.”
The FTSE 100 Index fell 0.8 percent today, taking its loss this month to 8 percent. Europe’s Stoxx 600 fell 1.2 percent after data showed the euro-area economy grew less than economists forecast in the second quarter.
In the U.K., inflation is outpacing wage growth, helping to squeeze households’ spending power by the most since the 1970s. EON AG’s British unit last week became the fourth of the country’s six major utilities to boost electricity and gas prices.
“On the upside, the key risk remains that the sustained period of above-target CPI inflation may push up on inflation expectations,” King said today. “Inflation will continue to be sensitive to fluctuations in global commodity and trade prices, but recent evidence of a moderation in global growth suggests that the risk of significant increases in those prices has diminished somewhat.”
The governor must write to the chancellor every three months when the inflation rate strays more than a percentage point from the bank’s target. Osborne, in a reply to King, said that he welcomes the MPC’s “commitment and determination to respond flexibly to the economic outlook and to set monetary policy to balance the upside and downside risks in order to meet the inflation target in the medium term.”
The chancellor also said he agreed with King that the “big risks” facing the U.K. come from the rest of the world.
“The U.K. is not immune to these external events,” he said.
The central bank will publish the minutes of its Aug. 4 policy meeting tomorrow, which will show if Martin Weale and Chief Economist Spencer Dale kept up their push for a rate increase.
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