Mervyn King gave his "evidence" to Parliament's Treasury Committee. It was depressing stuff. He said three things to MPs.
First, He expects inflation to rise further this year. Like in his earlier letter to the Chancellor, he was anxious to point the figure of blame away from the Bank of England and towards other exogenous factors. His list started with oil and gas prices, which are "now as high in real terms as they were in the 1970s." He also blamed the fall in sterling, which has pushed up the "prices of imported goods." Taken together, this all adds up to 4 percent inflation by the end of the year, and just in time for the spring wage bargaining season.
His second point rested on the observation that the food and energy prices were rising relative to other prices. However, this would not by itself, produce sustained inflation. For that, we must allow other prices and wages to rise at a faster rate. He claimed that the "MPC is focused on preventing that."
Notice he did not say that the MPC was determined on preventing that". Nor did he say, the MPC would "act to prevent that". All we can expect from the MPC is focus; lots of focus, ceaseless focus, determined focus, and relentless focus. It is not a time for action, merely an opportunity for focus.
Third, he admitted that the overall economic environment is seriously deteriorating. Inflationary expectations have risen; business surveys indicate that the economy has slowed; and real incomes are being squeezed.
In the face of this deterioarting environment, the MPC is performing a "balancing act'. The MPC needs a little slowdown to ensure that inflation "does not persist above the target". At the same time, "we need to avoid a slowdown that is so pronounced that it would pull inflation down, not just to the target, but below."
So, the MPC feel no responsibility for rising inflation. Nevertheless, they are not prepared to do anything except focus on inflation. They recognise that inflationary expectations are rising and that the economy is slowing. Like Goldilocks, they want just the right amount of economic slowdown.
Within a year, the MPC will have an inflation rate of around 5 percent. Low real interest rates will sustain downward pressure on sterling, which will ensure that prices will keep rising regardless of the economic slowdown. The economy will slow, unemployment will rise, but those who remain in work will still push for above inflation rates.
Why will the UK still have inflation while the economy slows. Well, if previous recessions are anything to go by, it takes an enormous increase in unemployment to reduce inflation. Typically, an unemployment rate of 3 million should be sufficient to keep a lid on prices. A more effective way of reducing inflation is to raise interest rates, and reduce the rate of growth of the money supply. This would also lead to an uptick in unemployment, but it would ensure a quicker recovery as inflation falls below the 2 percent target.
This time next year, the MPC will wish that had done more than just "focus" on inflation.