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Inflation worries Bank of England more than output drop

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The stubbornly high rate of inflation is causing the Bank of England’s rate-setting Monetary Policy Committee more sleepless nights than the fall in GDP recorded in the last quarter of 2010.

In a speech delivered in Newcastle, Mervyn King, the Governor of the Bank of England, said that inflation could reach as high as 5 per cent during the coming months.

Mr King added, however, that the cost of living would drop back in 2012.

The Treasury currently has an inflation target of just 2 per cent.

Import prices, more expensive energy costs and tax increases have fuelled the rise in inflation, Mr King said. The present rate – 3.7 per cent – has helped to squeeze earnings by 12 per cent.

Although he conceded that the figures for UK GDP during the final quarter of 2010, which showed a contraction in the economy of 0.5 per cent, were a reminder that the recovery is going to be “choppy”, Mr King went on to say that of “more immediate concern to the MPC is that we are experiencing uncomfortably high inflation”.

It was a “misapprehension” that the MPC “could have prevented the squeeze in living standards by raising interest rates over the past year to bring inflation below its present level”, the Governor continued.

He added that if the MPC had raised interest rates significantly then “inflation might well have started to fall back this year, but only because the recovery would have been slower, unemployment higher and average earnings rising even more slowly than now. The erosion of living standards would have been even greater”.