Inflation fears push up inflation

Monday 16th June 2008

Inflation could spiral if the public fears rising prices will storm out of control, the Bank of England warned today.

The Bank of England's Quarterly Bulletin out today reveals inflation will only stay low if the public believes the interest rate-setters of the monetary policy committee (MPC) are aiming to hold down price rises.

The bulletin states: "It is easier for monetary policy to achieve its objective of price stability if households and businesses believe that policymakers will do so — i.e. that inflation expectations remain close to the target in the medium term."

However, if the public start believing inflation will rage out of control – as it currently seems to be doing as food and fuel prices rocket internationally - employees start pushing for higher wages, which in turn can spur inflation.

Also fears about high inflation mean saving looks less promising – as if inflation rises to four per cent, a savings account at four per cent offers a zero per cent real return – so the push for spending increases. This too can increase inflation.

"A key risk for monetary policy makers is that inflation expectations move persistently away from the two per cent inflation target," the Bank publication stated.

"If that occurred, and those expectations became built into future wages and prices, there is a risk that inflation would remain away from the target for longer."

Bank data on inflation perceptions show the public now expect the consumer prices index (CPI) to hit 4.9 per cent.

CPI – which the Bank aims to keep at two per cent - is now at three per cent and it is expected to rise up to as much as four per cent in coming months before dropping back to target.

The sudden rise in inflation expectations is put down to fuel and food price increases.

"Households’ perceptions of current inflation have also picked up sharply over the past year, and by more than can be explained by movements in the official headline inflation measures alone," the report states.

"That divergence may be partly explained by differences in individual households’ experiences of inflation, the price rises of particular, frequently purchased items such as food and energy, and an increase in media discussions of rising prices."

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