Years of high inflation lie ahead
The UK should be braced for years of high inflation as the cost of living soars stubbornly ahead of wages, a leading economic forecaster warned.
The Ernst & Young Item Club said persistently high inflation had knocked almost 3 percentage points off the economy over the past three years and was set to remain above the Bank of England's 2% target "for the foreseeable future".
The latest predictions dampen optimism over an easing inflation outlook set out in the Bank's latest forecasts, which see the consumer prices index benchmark returning to 2% by mid-2015.
Figures from the Office for National Statistics are tomorrow set to show the first fall in the CPI since September last year as easing petrol prices bring down the annual rate of inflation from 2.8% to 2.6% in April, although this is still three times higher than average annual wage growth.
In contrast to the Bank's cheerier view, Ernst & Young forecasts that CPI will remain elevated at 2.5% throughout 2016, long after Threadneedle Street believes it will have returned to the target.
The forecaster warned outgoing Governor Sir Mervyn King's "Nice" decade of non-inflationary consistent expansion looks gone as the price of imported goods from emerging markets keep rising. Government policy decisions on tuition fee hikes are also set to raise the cost of living before a recovering economy bolsters workers' bargaining power and builds inflationary pressure, it added.
Despite oil prices falling from their $120 a barrel peak earlier this year, Sir Mervyn will probably have to write a letter in June explaining a rise of more than 1 percentage point above the 2% benchmark, Carl Astorri, the senior economic adviser at the Ernst & Young Item Club, said.
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One of Mervyn King's last acts as Governor will almost certainly be a letter to the Chancellor to explain yet another inflation overshoot. And further out it's unlikely that the UK will get back to the Chancellor's 2% target, he warned.
Ernst & Young's modelling showed the Monetary Policy Committee was right to allow inflation to overshoot without tightening policy, which the forecaster said could have sent unemployment soaring by an extra 625,000.
But it added that the prospect of high inflation over the long term could also tie the MPC's hands on providing extra stimulus to the economy or giving explicit commitments to keeping interest rates low depending on the state of the economy – a strategy the incoming Governor, Mark Carney, is known to favour.
Mr Astorri added: "As part of their new remit, the Chancellor is keen for the MPC to provide the market with forward guidance, whereby base rates would remain on hold until intermediate thresholds are met, while maintaining the over-riding importance of the inflation target.
"But, with inflation still above 2.5%, it's going to be tough, particularly if the MPC want to follow the US Federal Reserve's example of only increasing interest rates once unemployment has fallen below 6.5%. Either way, Mark Carney looks set for a difficult tenure."
One of Mervyn King's last acts as Governor will almost certainly be a letter
to the Chancellor to explain yet another inflation overshoot