After the ONS reported the surge in April's annual inflation to 4.5%, where inflation remained above the target for the third consecutive month, Mervyn King sent the second Open Letter this year to the Chancellor of the Exchequer to explain on the behalf of the MPC why inflation is above the target.
King again assured the Chancellor in his Open letter that the rise in inflation above target remains due to temporary factors. The letter read as set out in my previous letter, the current high level of inflation reflects three main influences: the increase in the standard rate of VAT in January to 20%, higher energy prices and increases in import prices. Although the impact on inflation of these factors is difficult to quantify with precision, it is likely that had they not occurred, inflation would have been substantially lower and probably below the target.
King reiterated in the letter the BoE's outlook for inflation and the period expected for it to return to target as mentioned in the Inflation Report. The high volatility in energy and commodity prices make it difficult to predict the outlook for inflation to return to target as the risk is for inflation is to the upside over the coming months, and as King said last week, likely to reach 5.0% in the coming months driven by energy prices.
Assuming the bank rate and the asset purchases move inline with market expectations, inflation will start to fall back in 2012 and 2013 and the outlook for inflation being above or below target are still broadly balanced.
King issued his second letter this year and the sixth since inflation rose above 3.0% in February 2010. According to the remit the BoE Governor is required to send and open letter of explanation to the Chancellor of the Exchequer once inflation deviates more than 1.0% from the 2.0% target, and in the BoE's case it has been to the upside since the series of letters started in February 2010.
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King assured in the letter that the BoE will continue to do all that is necessary to insure high and stable growth levels and employment, where downside pressures are still seen on the outlook for the recovery which remains the predicament among policy markers.