Mark Carney is committed to keeping the UK’s minimal policy interest rate for a long time. The Bank of England governor will not be challenged on this at Thursday’s meeting of the Monetary Policy Committee. But later this year the facts may force him to change his mind.
The disinflationary winds which have been blowing through the United States and most of Europe finally reached the UK late in 2013. The annual inflation rate has fallen to 2.1 percent. But over the last five years, the UK has been a laggard in inflation control. Since March 2008, the British consumer price index has increased at 3.2 percent annually, well over the Bank of England’s 2 percent target and the comparable 1.9 percent in the U.S. and 1.7 percent in the euro zone.
The central bank is now inside its own inflation safety zone. But prices are still increasing far faster in Britain than across the Channel and the Atlantic. The UK economy is also strengthening quickly. Estimates of 2014 GDP growth are now solidly over 2 percent. Manufacturers are investing, unemployment is falling and another sort of inflation – in house prices – is encouraging consumers to become more profligate.
All is not yet well with the economy. Some retailers had a terrible Christmas and wage increases remain paltry. Also, a strong pound, which keeps import prices down, holds inflation in check.
That could all so easily go wrong. Housing inflation could spread to other prices. Traders’ fears about the current account deficit – currently 4 percent of GDP – could bring the pound down and inflation up. As hiring picks up, a shortage of skilled workers could trigger higher wages.
Suppose the British inflation rate rises above 3 percent. That is not what the Bank of England expects, but its forecasting record on the matter is dreadful. If inflation remains low elsewhere else, the British exception could frighten the markets.
The Bank of England would be left with little choice. Increasing the cost of borrowing would be the only credible way to defend the country against a sterling crisis.