Bank of England Deputy Governor Charles Bean said the strength of inflation has increased the risk to price expectations and there may also be less spare capacity in the economy than previously assumed.
“Given the unexpected strength of inflation in recent months, this risk has probably increased of late,” Bean said in a speech at an event organized by Market News International in London today. “We shall be watching these indicators, and their impact on wages and prices, like proverbial hawks.”
Policy makers have split three ways on whether to focus on curbing an inflation rate that has exceeded the government’s 3 percent upper limit for eight months, or the risks to growth from the government’s planned spending cuts. The Monetary Policy Committee last week left the emergency bond-purchase plan unchanged at 200 billion pounds ($315 billion).
There are still risks “to both sides” of the economic outlook, Bean said in answer to questions, adding that an “unhappy” outcome to the euro-area crisis may yet trigger an increase in so-called quantitative easing.
“It is certainly possible we may want to undertake a second round of QE if the outlook for U.K. growth and inflation prospects is slowing,” he said.
The outlook for U.K. growth still “remains highly uncertain,” Bean said. “The important thing for us is whether an intensification of the difficulties in the euro-area periphery could also derail the recovery here.”
Bean noted that private-sector demand and exports are showing signs of picking up and that overseas sales may continue to strengthen because of the weakness of the pound.
“As 2010 draws to a close, the good news, then, is that the recovery, here and more widely, has remained on track,” Bean said. Moreover, the high rate of inflation “could indicate that the margin of spare capacity is not as large as the collapse in activity might suggest,” he added.
Bean said that the economic recovery is showing signs of persisting in the current quarter.
“If all goes to plan, however, and private final demand continues to pick up the baton as the fiscal consolidation proceeds, then the margin of spare capacity will shrink and it will at some juncture become appropriate to begin withdrawing the current extraordinary degree of monetary stimulus,” he said. “When that point comes, the MPC will aim to do so in a timely, but measured, fashion.”
Bean also said that the change in longer-term inflation expectations has been “relatively modest.”
“Measures of inflation expectation in the short-term in the next year have moved up,” he said in answer to questions. “What we would be more concerned about would be a rise in longer-term inflation expectations. So far the move in those longer-term inflation expectations has been modest.”