The Bank of England may have to send a flurry of open letters to the Chancellor if the present volatile economic conditions prevail, Monetary Policy Committee member Kate Barker warned yesterday.
Speaking at the North Staffordshire Chamber President's Dinner, she said shocks inevitably occurred which drove the economy away from the path of steady growth and low inflation for a time.
"At present we are faced with a number of significant shocks, most notably the ongoing uncertain conditions in credit markets, rising oil and commodity prices and a sharp fall in the exchange rate," noted Ms Barker.
"As these various shocks play out in the domestic economy, it is highly likely that for a period output growth, and more particularly inflation, will prove volatile."
There were clear signs of a marked weakening in both the commercial and residential property markets.
Commercial property prices fell by 12 per cent in the second half of 2007, and latest data from the major lenders suggested that house prices declined slightly over the three months to January.
"While the outlook for house prices is always highly uncertain, it is likely that prices will decline in the short-term relative to earnings, and falls in nominal terms cannot be ruled out," she cautioned.
However, the large rise in house prices over the past decade had resulted in high levels of housing equity, which meant there should be ample opportunity to borrow against that for many even if house prices were to fall.
"More important risks relate to the effects of the credit market tightening, including the risk that some less high quality borrowers reaching the end of two year fixed-rate mortgages during 2008 may find that they have to re-finance onto the much higher standard variable rate. The impact of this could be very significant for those households, but should not be so for the economy as a whole."
However, if credit tightening were to prove more severe than in the MPC's present central projection, leading to a significant fall in lending to households and companies, this could prompt a further decline in property values.
"The consequent adverse impact on growth could prove difficult to turn around quickly, potentially resulting in a protracted period of low output growth and below target inflation," noted Ms Barker.
"Unfortunately, the strong upward inflation pressures in the UK today make it difficult to argue for large reductions in bank rate to reduce this downward risk. Higher global prices, particularly for energy and food, are still feeding through the supply chain, amply illustrated by the sharp rises in producer price inflation in January. Including the estimated impact of the announced rises in domestic energy bills, CPI inflation is expected to be considerably above the two per cent target for much of the rest of 2008.
"A period of above-target inflation, driven primarily by global factors, is not necessarily a concern. The central projection in the latest Inflation Report makes it clear it is more likely than not that over this summer CPI inflation will reach the level where an open letter from the Governor will be triggered for only the second time.
"Not too much significance should be attached to this. When the MPC was first established, it was suggested, on the basis of recent past experience, that these open letters would be quite frequent. In fact, there were few large supply side shocks in the first decade of the MPC, and inflation was kept within one per cent either side of the target in all but one month.
"But the recent sequence of shocks stemming from oil and commodity prices, and the exchange rate, inevitably leads to greater short-term inflation volatility. Open letters may well become more frequent.
"Indeed, were energy prices to fall back sharply in the next twelve months, there would be a risk of an open letter because CPI inflation is too far below target.
"The real concern is whether this renewed bout of inflation well above target could spark off a lasting rise in inflation expectations that posed a serious risk to keeping CPI inflation on target. If this occurred, it could be very costly to reverse."
The short-term indicators were "worrying".