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Friday, 17 September 2010

My interview at the British TUC Congress by DOW JONES in New York

MPC Hopes To Retain Trust Despite High Inflation


MANCHESTER, England -- The Bank of England is facing the biggest challenge to its credibility since it gained independence over monetary policy in 1997.

The BOE's Monetary Policy Committee is charged with keeping inflation at 2.0%. But for 41 months out of the past 50, price growth has been above that level, and the central bank admits it will continue to exceed its target until the end of next year.

That contrasts with the U.S., Japan and the euro zone, which have all recently flirted with consumer price deflation.

In its defense, the BOE cites a series of temporary factors that have kept the inflation rate high, even as the economy entered a deep recession, and then began a sluggish recovery.

They include high commodity prices, rising import prices as a result of sterling's depreciation, and increases in the sales tax. Indeed, a further hike in the latter to 20% from 17.5% at the start of 2011 is one reason why the inflation rate won't fall back to target in the early months of next year.

Charles Goodhart, a professor at the London School of Economics and a former member of the MPC, said "everybody appreciates that's a one-off that the Bank is not really going to be held responsible for."

But he added that the BOE is running out of excuses.

"Nevertheless, they really have been saying too often "We're going to get it down within the next two years," and if they don't get it down by the end of 2011, a lot of fairly nasty questions will start to be asked," he said.

The central bank seems aware of its vulnerability.

In his opening statement at the quarterly Inflation Report in August, King felt the need to preempt questions on whether the BOE was serious about keeping price growth at 2.0%.

"Over the past three years, inflation has been volatile and above the target for much of the time. That does not mean that the MPC has taken its eye off the inflation ball, nor has gone soft on inflation. We have not," King stressed.

Speaking at the Trades Union Congress in Manchester Wednesday--the first appearance by a BOE governor in over a decade--King turned on the charm, talking of the injustice of banks being bailed out by the taxpayer while workers suffered.

But inflation was conspicuously off the agenda.

"We at the Bank of England and you in the trade union movement should work together," King said. "It will require patience and determination on all our parts, including your members. But the prize of restoring and maintaining economic stability--and a return to sustained rises in employment and living standards--will be worth the effort."

In the euro zone, the European Central Bank speaks explicitly about a contract with the unions, whereby policymakers keep inflation low, and workers don't demand unreasonable pay awards.

While the BOE doesn't use the language of social partners and solidarity that is common in continental Europe, its success in controlling inflation over the longer term is just as dependent on winning and keeping the trust of the general public.

The existence of an inflation target is supposed to reassure workers that prices will on average rise at that moderate pace every year. In turn, the BOE hopes that workers will not demand big pay rises that are intended to cushion them against unpredictable surges in costs.

But if the inflation rate remains above target for a long period of time, the danger is that workers will lose faith in the central bank, and start to demand much larger wage increases.

The official union view is polite and understanding.

"Trade unions know that if the bank was to get tough on inflation, that would mean higher interest rates, which would reduce economic growth and increase unemployment," said Nigel Stanley, head of campaigns at the TUC.

That "would be extremely bad news for people at work and in many ways make it even less likely that unions could bargain for higher pay increases to keep up with inflation. It would probably be a loss-loss game."

But in the audience, workers were feeling the pinch.

Richard Jacques, a secretary from England's East Midlands, said he was angered that King had the "audacity" to come to preach to the unions.

"He's making the pound worthless in our pocket," Jacques said. "The cost of a loaf of bread, the cost of petrol. Yet we as workers are expected to take a pay cut in real terms. We still have to drive our car; we still have to buy the petrol to drive it; we still have to feed our kids. And we are not supposed to go on strike apparently."

There are some signs that workers are beginning to assume that inflation will be high in the future.

A quarterly poll released by the Bank of England Thursday showed the U.K. public expected prices would increase by 3.4% over the next 12 months, up from 3.3% in May and marking the highest rate since August 2008.

In contrast, longer-term inflation expectations--which the central bank watches more closely--have been relatively stable, and private and public sector pay growth has been subdued.

For one former MPC member, the BOE has not yet lost the public's trust.

"The issues for credibility are how well the central bank is able to communicate why inflation is volatile and how it is setting policy to get inflation back to target," says Kate Barker, who worked at the BOE for nine years until this summer.

"While the period of above-target inflation poses some risk to credibility, the indications from most measures of inflation expectations are that so far this risk has been managed successfully," she said.

---By Natasha Brereton, Dow Jones Newswires; +44 20 7842 9254;

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