King defends decision not to raise interest rates

Mervyn King, the governor of the Bank of England, has defended the decision not to raise interest rates.

Mervyn King
Mervyn King

Giving evidence to the Treasury select committee this morning, King said the prolonged elevation was down to “temporary shocks”.

King said: “It would have been wrong to have raised interest rates markedly over the past year deliberately in order to create a deeper recession in order to bring down inflation that was the result primarily of what we believe to be temporary shocks.”

He said: “If there are shocks to the economy which temporarily push inflation away from target, that were the result of supply shocks, we would work through that and set in place measures to ensure in the medium term the target is met.”

He added: “I think that was what we were seeing the past two or three years.”

Andrew Sentance, a member of the MPC, said: “The concern I have is not that it is not appropriate at times when you get one off shocks to inflation to allow those to feed through and allow inflation to go back to target but we have had this happening on a persistent basis.”

He added: “I think it is becoming increasingly difficult to explain to the public and the business community that we are not reacting in some way to inflation that is persistently above target.” (article continues below)

King said inflation had been high because of the change in exchange rates since 2007, the rise in commodity prices and VAT returning to 17.5% after a temporary cut.

He said the forthcoming rise would leave VAT elevated for another year or so but the important thing was the prospect for inflation in the medium-term.

He said: “The risks in the medium-term are dominated by whether spare capacity in the economy would pull inflation below the target or whether prolonged period of above target inflation out-turn will push up inflation expectations keeping inflation above target.”

Adam Posen, another MPC member, said a sharp rise in inflation was unlikely.

He said: “There is no precedent for a country to have an independent bank, seeing an austerity programme in fiscal policy, with an inflation target and wage growth at 2%  or less having a sharp sustained rise in inflation.”