UK inflation ‘likely to remain volatile’

INFLATION in the UK is still likely to fall back towards target during 2011 despite remaining stubbornly high for several months, a Bank of England interest rate-setter said during a visit to Suffolk yesterday.

But Professor David Miles, who joined the bank’s Monetary Policy Committee in June last year, warned that inflation was likely to remain relatively volatile over the coming years.

He spoke to the EADT following a private lunch-time meeting with members of Suffolk Chamber of Commerce to gauge business sentiment in the county, held at the Ufford Park hotel and golf complex near Woodbridge.

Prof Miles said the overall impression from the meeting – one of a regular series attended by members of the MPC around the country to keep in touch with the business community – was one of concern over the strength of the economic recovery.

“I think most people in this part of the world are in a better position than they were 18 months ago but it has been a relatively muted recovery,” he said.

“From my point of view on the MPC, I am particularly concerned about inflationary pressures, since it is our job to keep the rate close to the 2% target and it is uncomfortably above that at present.”

However, soundings at the meeting about wage settlements among the 100 or so businesses represented at the event showed that a majority were in the range of 1% to 2%, which was a relatively reassuring picture.

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Prof Miles, who has worked in both business and academia, being a former chief UK economist at Morgan Stanley and now a visiting professor at Imperial College, where he was formerly head of the finance department, said CPI (Consumer Prices Index) inflation was likely to remain at around 3% “for a good few months yet”, particularly in view of the increase in VAT to 20% due to kick-in in early January.

By the end of next year, however, and going into 2012, it was more likely that inflation would ease back close to the 2% target, or even dip a little below it.

One of the big areas of uncertainty, however, following such a turbulent period for the economy and the sharp recession, was the level of spare capacity.

“I think it is likely that there is a lot of spare capacity in the UK and that would keep inflationary pressure in check but there is a great deal of uncertainty about that,” he said.

“My impression is that a majority of businesses do have spare capacity and would not find it difficult to supply an increased order book.”

However, should the recovery seen during the first half of 2010 continue its momentum during the second half then inflationary pressure would grow, requiring some of the stimulus applied to the economy to be withdrawn.

Where this to happen it would not be a bad outcome as it would signal that the recovery was relatively robust.

Prof Miles added that while CPI inflation had remained in a narrow band either side of target in the period before the recession, it was less likely that this would be the case in the years ahead.

Since September last year alone, inflation has risen from barely 1% to nearly 4% and was now back down to just above 3%.

Although we had become accustomed to the relatively stable inflation seen in the pre-recession era, it was this which might, in retrospect, come to be seen as having been unusual, rather than the greater volatility now being seen, he added.