The Office for National Statistics yesterday revealed consumer price index inflation hit 5.2% in September, up from 4.5% the previous month.
However, in a speech to the Institute of Directors in Liverpool last night, Mervyn King explained why it would begin to fall and how that was shaping the Bank’s policies.
He said: “In contrast to headline inflation, domestically generated inflation remains subdued – and on some measures barely above zero. Increases in energy prices, import prices and VAT account for the current high level of inflation.
“Once the effect of these temporary factors begins to dissipate, inflation should fall back sharply early next year.
“A persistent margin of spare capacity in the economy, and the recent deterioration in demand prospects linked to the crisis in financial markets, will add to the downward pressure on inflation in the medium term.”
He added this was the reason for the Monetary Policy Committee’s recent decision to resume its asset purchase programme, to ensure it does not fall below the target 2% rate, and gave the audience a brief guide to the goals of quantitative easing.
“When the Bank buys assets, the people who sell the assets to us receive money which can then be used to buy other assets. In turn, the sellers become buyers of other assets, and so on indefinitely as the money is transferred from one account to another,” he explained.
“The prices of assets that investors choose to buy go up, raising wealth and pushing down on yields. Those yields are the opposite side of the coin to the borrowing costs of companies. In these ways, the Bank’s purchases of assets increase demand in the economy.”
King concluded his speech by saying the global crisis had provoked a “bold response” in 2009 and required another one now.