The Bank of England's Monetary Policy Committee will tolerate missing the inflation target for the next two years in order to support the UK recovery, said Bank governor Mervyn King.
Presenting a downbeat quarterly inflation report, outgoing governor King said the Bank must play the hand it has been dealt and manage higher inflation for longer.
The report suggested inflation would not fall back to its 2% target until 2016.
His comments echo those of incoming governor Mark Carney, who said in a speech at the World Economic Forum in Davos last month that he is willing to see higher inflation for longer in order to boost the economy.
Speaking this morning, King said of missing the target: “It is not desirable, but it is the hand we have to play.”
The inflation report said overall UK output has been broadly flat over the past year, overlooking temporary factors, reflecting sharp falls in particular sectors of the economy which are unlikely to be repeated in 2013.
“CPI inflation is likely to rise further in the near term and may remain above the 2% target for the next two years. But inflation is expected to fall back to around the target thereafter, as a gradual revival in productivity growth dampens increases in domestic costs and external price pressures fade,” the report said.
Asked whether the Bank would consider a return to the 1%-4% target range adopted in 1993, King said this was only ever a temporary range.
“We are not saying 2% target is unattainable, there is actually quite a good chance of hitting it, indeed we may go below it, it is just very uncertain. The reason we had the 1%-4% range was that it was a temporary target, it was not meant to be a permanent one."
King reiterated the UK economy is on the path to recovery, although it will not necessarily be straightforward.
“The UK economy is set for a recovery, but is not to say road ahead will be smooth.
“Growth will be weak in the near term but, further out, an easing of credit conditions including the Funding for Lending scheme will underpin a slow but steady recovery in output,” he said.
King added inflation has remained “stubbornly above the 2% target”, could rise in the near term, and may remain above target for the next two years, impacted by a lower exchange rate.
However, any attempt to bring back to target sooner could risk derailing the recovery in growth and in employment, the governor added.
Vicky Redwood, chief UK economist at Capital Economics, said the gloomy inflation report shows the Bank of England is already enacting policies hinted at by Carney, who takes office in June.
“The Bank of England has presented another gloomy inflation report, showing inflation projected to be stronger over the next couple of years even though the recovery is still expected to be sluggish. As last week’s MPC statement had hinted, inflation is now expected to be above its 2% target for all of the next two years.
"In fact, even at the two year horizon, inflation is still projected to be a bit above 2%. This partly reflects the impact of sterling’s recent fall; the growth forecasts look largely unchanged (at about 1% this year and 2% next)," she said.
"At the press conference, Mervyn King stressed the Committee would look through this “temporary albeit protracted period of high inflation in order to support growth and employment.”
"In other words, the MPC is already taking the flexible approach to inflation-targeting that the governor-to-be Mark Carney has advocated. So there is little chance of the MPC tightening policy on the back of this."
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