The Chancellor should be expecting a letter soon after Mark Carney accepted inflation is set to dip below one per cent.
The Bank of England governor predicted the inflation slump over next six months and said markets were right to rule out an interest rate hike any time soon.
When asked about the prospect of deflation, he told the Post that the Bank’s stimuli were working, as shown by record low mortgage rates.
He predicted a slow and steady rise in inflation towards the Bank’s two per cent target.
He also said interest rates would rise, although markets are expecting rates to remain at their record low for almost another year.
In an interview with the Post, Mr Carney said: “Our stimulus is flowing through the economy and that is appropriate because we are going to go through a period now where inflation is low – we think it is probably going to dip below one per cent, so I will be writing a letter to the Chancellor to explain why that is the case – and it will take some time before it starts to creep back up towards that two per cent target.
“But we have the means to provide that stimulus.
“What that means though, for this economy to have balance and inflation to get back to two per cent over the next few years is that is going to mean in all likelihood, in our opinion, that interest rates are going to have to increase.”
Mr Carney pointed to the eurozone as an area of concern, with the country’s main trading partner at risk of falling back into recession.
“Our message is that interest rates are going to increase,” he said. “We don’t know the precise timing that will start, but what we are emphasising to businesses, to mortgage-holders, to homeowners and to individuals is that what’s most important is the path of interest rate adjustments. That path is expected to be a gradual set of interest rate increases and to a more limited extent than the past.
“The reasons for that are weak export markets, we have a financial sector that is doing much better but it is still continuing to heal, we have ongoing fiscal adjustment and you can debate about different parties might do different things but the direction of travel is pretty clear. On top of that we have quite low inflation right now – past appreciation of Sterling is still flowing through – so there is a variety of factors.”