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Surging U.K. inflation ratchets up pressure Add to ...

If one central banker anywhere is in the hot seat, it is Mervyn King, Governor of the Bank of England.

Since he became Governor in 2003, Mr. King has seen a boom economy fall apart, producing one of the world's worst banking crises and a deep recession. Now he has to confront soaring inflation at a time when higher interest rates, the normal inflation-fighting prescription, could wreck Britain's tentative recovery.

Economists are divided about his next move after inflation surged to an annual rate of 3.7 per cent in December, an eight-month high, well above expectations and almost double the bank's 2-per-cent target. In December alone, prices were up 1 per cent, the most since records began in 1996, propelled by rising fuel, transportation and food costs.

Some economists say Mr. King will urge his rate-setting committee to raise rates quickly; others think he will resist increases until it's clear the economy is strong. What is certain is that Britain's era of ultra-low rates - the Bank of England left them at 0.5 per cent last week - is coming to an end. It's just a question of when, and getting the timing right is crucial as the country grapples with high unemployment and one of Europe's most aggressive austerity programs.

Scott Corfe, an economist in London at the Centre for Economics and Business Research (CEBR), said he doubts the Bank of England will risk a rate hike this year "because of weaknesses in the economy." Already, he thinks there is a 20-per-cent chance of a double-dip recession.

Mr. Corfe said a rate increase, were it to come earlier, would be ineffective because "temporary factors" seem to be driving the inflation rate. He was referring the twin increases in the value-added tax (VAT), the first last year, which took the tax from 15 per cent to 17.5 per cent, the second on Jan. 1, which took it to 20 per cent. (VAT increases have been either lower or absent in the rest of the European Union.) Without the VAT hikes, he figures the annual inflation rate in December was only 2 per cent - bang on the Bank of England's target.

Other economists think rates will have to rise this year. Some expect the inflation rate to hit 4 per cent within months and that the central bank would jeopardize its credibility if it were to hold tight on the assumption - possibly wrong - that inflation will swing down once the VAT increases have worked their way through the system and as high unemployment keeps a lid on labour costs.

The European Commission notes that British inflation rates have consistently been higher than expected. "As the high inflation persists, the assumption that it is driven by temporary factors becomes harder to maintain" the EC said in its autumn economic forecast.

European economists at National Australia bank think the first rate increase could come as early as April. Italy's UniCredit bank said a hike will come in the fourth quarter, though there is some risk it will come earlier.

Mr. King wasn't speaking about his intentions, but in an interview published in the Yorkshire Post Tuesday, Paul Fisher, the Bank of England's executive director for markets, suggested the bank wasn't about to hit the rate-increase button soon. "We have to look through those short-term things, despite whatever unpopularity comes our way, to try and set the best policy rates for the medium term," he said.

While inflation is ticking up across Europe, some British politicians worry that the unusually high British inflation will trigger a populist backlash. That's because inflation erodes living standards when wages aren't rising and punishes savers.

Conservative MP Michael Fallon, who is a member of the panel that scrutinizes the Bank of England and the Treasury, told BBC Radio earlier this week that he thinks rates should rise sooner rather than later. "They will have to work out whether, given [that rates are]going to go up anyway, whether it'd be better now to start raising gradually, or whether they're prepared to face a very sudden increase later in the year," he said. "I'd tend to be a 'now man' because we've had constant reassurances that inflation will fall and it hasn't fallen."

Prime Minister David Cameron has said he is "concerned" about rising consumer prices. The Conservatives, however, have made it clear that the Bank of England is independent and that rate decisions belong to the bank, not the government.

 

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