The Bank of England is on a mission – to control inflation and help the country ride out the economic storm. Economics Editor Nevill Boyd Maunsell reports

The Bank of England and its governor Mervyn King have embarked on a hearts and minds campaign to persuade MPs and a wider audience of pay bargainers and industrialists that they can and will drive inflation back to the Government’s two per cent target.

Giving evidence to the Commons Treasury Select Committee, Mr King and colleagues from the Bank’s interest setting committee insisted the present surge in prices of food, oil, electricity, gas and imports generally will be a one-off spike – provided it is not matched by a burst of pay increases for British workers and price rises by British manufacturers.

Michael Fallon, the committee’s chairman, challenged Mr King that he had failed to hold down expectations of future inflation. He pointed to a recent survey published by the Bank itself showing that most people expect the cost of living to rise at 4.3 per cent over the next year, more than double the Bank’s target.

The governor replied that the Bank had brought inflation down after a similar spike in March last year. “I believe we can do it again”, he said.
Earlier he told the committee the economy has to slow down this year to cool these expectations.

The economy is slowing, but possibly not enough for the Bank’s purpose. Mr King warned that inflation is set to rise above four per cent this year, though the extent will depend largely on the size and timing of the coming round of gas and electricity prices, which the utility companies say is inevitable.

“The economic slowdown will need to be sufficient to ensure that inflation does not persist above the target,” Mr King declared.

But he then added “At the same time we need to avoid a slowdown that is so pronounced that it would pull inflation down, not just to the target, but below” – in other words a recession.

He added grimly “I am confident that we will bring inflation back to the target, but I cannot tell you what level of interest rates we will need to achieve that.”

The underlying message is that Britons face a fall in their standard of living. Money absorbed by dearer food, petrol and utility bills is no longer there to spend on other things.

The Bank fears that public sector unions and pay bargainers in the private sector could de-rail its mission to cool inflation by defending living standards here and now with inflation-matching pay deals.

This has not happened so far. The Bank fervently hopes the Shell tanker drivers’ strike that won them 14 per cent over two years does not become a precedent.

A stiffer test may come shortly from 600,000 local government workers, from bin men to municipal architects, who have voted to strike in support of a six per cent claim.

If they get anything like that, the even bigger civil service union is waiting in the wings threatening to renounce its existing 2.5 per cent deal on the – factually correct – grounds that fast-rising prices have turned it into a pay cut.

Mr King rarely comments on the housing market, claiming that house prices have little bearing on other prices. In any case, are not included in the index used for the Bank’s inflation target.

But on Thursday he went out of his way to be reassuring, while noting that house prices rose to a level not “entirely easy to rationalise” in the recent boom.

He highlighted the differences between the present situation and the housing slump of the early 1990s. Repossessions are less than half the number seen then, he said.