King Says U.K. Faces Inflation Bout Plus Weak Growth

Bank of England Governor Mervyn King said Britain faces a further bout of inflation and a muted economic recovery, and pledged officials will look through the volatility in prices to keep nurturing growth where they can.

“Inflation is likely to rise further in the near term and may remain above the 2 percent target for the next two years,” King said as he presented the central bank’s Inflation Report in London today. “The MPC’s remit is to deliver price stability in the medium term in a way that avoids undesirable volatility in output in the short run. The prospect of a further prolonged period of above-target inflation must therefore be considered alongside the weakness of the real economy.”

The pound fell as King spoke on the dilemma of a weak recovery and above-target inflation that has plagued the Monetary Policy Committee for more than three years and is set to overshadow the last few months of his tenure. The BOE said today it sees inflation at about 2.3 percent at the end of its two-year forecast period, and a “slow and sustained” recovery.

“If necessary, we will do more,” King told reporters. “We must recognize, however, that there are limits to what can be achieved via general monetary stimulus -- in any form -- on its own.”

The pound fell 0.8 percent against the dollar to $1.5544 as of 4:07 p.m. London time. It earlier declined to $1.5524, the lowest in more than six months. Government bonds fell, pushing the 10-year yield up 11 basis points to 2.21 percent.

Inflation Outlook

In its report, the BOE said the outlook for consumer-price growth is higher than forecast in November because of the weaker pound and increases in energy bills. It also warned that weak productivity is boosting domestic cost pressures.

“Attempting to bring inflation back to the target sooner by removing the current policy stimulus more quickly than currently anticipated by financial markets would risk derailing the recovery and undershooting the target in the medium term,” the BOE said in the report. The MPC said it “stood ready” to add to stimulus if needed.

“While there is little room for further monetary easing in the current committee’s mind, there is equally little appetite for any tightening in policy,” said David Tinsley, an economist at BNP Paribas SA in London and a former Bank of England official. “Our assumption remains that there will be no more quantitative easing on the current governor’s watch.”

King is due to retire at the end of June and will be succeeded by Bank of Canada Governor Mark Carney.

‘Cause for Optimism’

The MPC left its benchmark interest rate at a record low of 0.5 percent last week and the target for its bond purchases at 375 billion pounds. Financial markets don’t have an interest-rate increase fully priced in until the fourth quarter of 2015.

King noted that “there is cause for optimism,” and that, just as there was 20 years ago, “a recovery is in sight.” He pointed to the fact that there is a “more encouraging underlying picture” in the economy than overall data including construction might suggest.

Prime Minister David Cameron’s view is that the U.K. economy is “healing,” his spokesman, Jean-Christophe Gray, told reporters today in London.

The central bank also offered what it said was a “cautious” view of the potential impact of its Funding for Lending Scheme, noting that uncertainty among consumers and companies may curb demand for loans. It also said that banks are only partly through balance-sheet repair and that competition between lenders may need to improve.

“The MPC’s projections assume that improved credit conditions are accompanied by a modest rise in the demand for loans and that this feeds through fairly slowly into aggregate demand and effective supply,” it said. “That relatively cautious stance reflects a judgment that the private sector is still adjusting to the reassessment of economic prospects.”

Inflation Outlook

U.K. inflation held at 2.7 percent last month, the highest rate since May. On the outlook, the Bank of England blamed the weaker pound, increases in prices of regulated items such as university tuition and utility bills, and weak productivity. The pound has fallen 3.7 percent versus the dollar since the start of the year and is down about 6 percent against the euro.

“What we have been surprised by since the last report is the impact of these administered prices in pushing inflation up,” King said. “It is a bit of a self-inflicted goal in terms of the damage done to real take-home pay, perhaps another way of trying to implement fiscal consolidation through moving up the price level. This is not the result of easy monetary policy and nor does it reflect what’s going on in the economy.”

Slow Recovery

Britain’s economy shrank 0.3 percent in the fourth quarter of 2012 after a year of what King has called “zig zag” pattern of growth. The central bank said today that over the past 12 months, overall output has been “broadly flat.”

It forecast a “slow but sustained recovery” for the U.K. supported by its loose monetary policy and an improvement in the global environment. Still, it noted downside risks, including from continued threats from the euro-area debt crisis.

Data today showed that euro-area industrial production increased 0.7 percent in December, more than economists forecast, adding to signs the economy may be gaining strength after slipping into a recession last year.

In the U.S., retail sales rose 0.1 percent in January, compared with a 0.5 percent increase in December, as an increase in payroll taxes took a bite out of consumers’ paychecks. Separately, inventories climbed in December at the slowest pace in six months.

King said that optimism in financial markets may not reflect the underlying data on economies around the world. The FTSE 100 Index has gained 7.5 percent this year, adding to its 5.8 percent increase over 2012.

“I am concerned that some of the optimism of financial markets, welcome though it is to have that degree of optimism, may not be consistent with the speed at which the underlying data are likely to change in terms of trade positions and growth, particularly in other countries in the world,” King said. “The underlying data don’t seem to be living up to the optimism in financial markets. That may change. Maybe financial markets may be proved right.”

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