Rising oil prices biggest inflation risk, says bank chief

Bank of England rate setters said yesterday that a further rise in oil prices posed the biggest threat to efforts to bring runaway inflation under control.

The central bank’s monetary policy committee (MPC) expects inflation to soar above 4% this year – more than double its 2% target – but has previously stressed the temporary nature of the spike.

Governor Mervyn King told MPs on the Treasury select committee that a further rise in oil prices – which hit a record of almost $140 a barrel earlier this month – would make it that much more difficult to control the cost of living and could prompt action from the MPC if it fed into wage demands.

His warning comes amid predictions from some City analysts that oil prices could even hit $200 a barrel.

Bank director Paul Tucker added: “The greatest hazard that we could encounter is that oil continues to rise . . . and ‘temporary’ gets extended.”

Mr King said there was no magic bullet to protect the UK economy from the high prices but said that the current elevated cost of oil contained the seeds of its own destruction because of the impact on demand.

The bank’s policymakers are also facing the headaches of rising food costs and the prospect of higher household energy bills, which they have said will lead to a temporary pause in the growth of families’ standards of living this year.

The governor said he was confident of getting inflation back to its 2% target within the two-year time frame of the MPC but gave no hint on the direction of interest rates.

He said the committee would not make gestures in either direction and added: “I’m confident that we will bring inflation back to the target but I can’t tell you what level of interest rates we will need to see to achieve that.”

Last week, Mr King was forced to write an open letter to Chancellor Alistair Darling as the bank’s official inflation benchmark soared to 3.3% in May, the highest in the 11 years of its independence.

The governor faced criticism from MP Michael Fallon that he had failed to anchor inflation expectations after the bank’s latest survey showed the average expectation of the rise in the cost of living at 4.3% over the next year. Mr King said the MPC had brought down inflation once following a spike in March last year and added: “I believe we can do it again.”

There were further warnings for homeowners faced with a market downturn as Mr King predicted an extremely weak period of activity ahead for house prices.

While mortgages have been restricted by banks and lenders rebuilding their finances in the wake of the credit crunch, he added that there were many differences between the current downturn and the previous slump of the early 1990s.

Repossessions were at less than half the level seen then, Mr King said, while interest rates and employment were also more stable.

Howard Archer, Global Insight’s chief UK economist, said the comments of the rate-setters were pretty balanced and suggested that the bank was in no hurry to shift rates from the current 5%.