13th March 2015
Bank of England governor Mark Carney has said the UK will return to its 2% inflation target in two years thanks to the strength of the economic recovery.
Speaking to business leaders in Sheffield, Carney said that despite external global forces – such as weakness in overseas economies – a return to higher than inflation pay increases will see domestic demand and prices rise, leading to increased inflation.
However, this will also force the Bank to increase interest rates from their low of 0.5%, where they have sat for the past six years.
Before this happens though, inflation is likely to dip from its historic low of 0.3% to sit at zero over coming months, with the distinct possibility of negative inflation. The reason for this inflationary drop is falling oil prices coupled with the value of the pound alongside weak growth in China and the eurozone.
Carney said: ‘While the [Bank’s] Monetary Policy Committee (MPC) can be expected to look through one-off shocks, it may be appropriate to take into account persistent external deflationary forces arising from the combination of continued foreign low inflation and the protracted efforts of sterling’s strength on the prices facing UK consumers if those forces were to intensify.’
He added that UK wages – which are predicted to grow 3.5% this year – would act as a counterbalance to global forces pushing inflation down and help the Bank reach its 2% inflation target again.
‘The Bank expects to return inflation to target within two years and to make limited and gradual increases in Bank [interest] rate over the next three years in order to achieve that in a sustainable manner,’ said Carney.
However, there has been criticism that the wage growth expected in the UK will not materialise and Carney said that stagnant wages would create a problem.
‘A debt-deflation dynamic was at the core of the Great Depression and in the Japanese malaise following the collapse of the asset bubbles of the 1980s. It would be a particular concern if the pace of wage growth were to follow prices down. There is no evidence of that in the UK, where wage growth has picked up over the past six months,’ he said.
‘And more broadly, following the 2008 financial crisis debt deflation has been the dog that hasn’t barked. But we shouldn’t rest too easy – there are several reasons why the dog might have just been sleeping, and central banks need to be vigilant against the risk that recent low inflation stirs it from its slumber.’