Bank Governor writes off 'temporary' inflation rise

Mr King has to write a letter to the Chancellor in the event that inflation is more than one per cent above the Bank's two per cent target.

January's 3.5 per cent was the highest level for the Consumer Prices Index measure of inflation since November 2008.

In his correspondence, Mr King said: "Although it is likely to remain high over the next few months, inflation is more likely than not to fall back to the target in the second half of this year."

He said VAT going back up to 17.5 per cent, a 70 per cent rise in oil prices over the past year and the effects of sterling's depreciation had all played their part in the inflation spike.

Mr King said the Bank's Monetary Policy Committee believed the rise was a "temporary deviation" from the target.

He said that in the longer term the measure would be dragged lower by weak spending, which has created a "substantial margin of spare capacity within the economy". This has already been seen in weak wage growth, he added.

The Governor said the effects of the Bank's 200bn quantitative easing programme to boost the money supply and record low interest rates would continue to aid the economy for some time.

He said the MPC was ready to take "whatever actions are necessary to ensure the outlook is for inflation to remain in line with the two per cent target".

Mr King also reiterated his comments last week that the quantitative easing scheme – which has recently come to a halt – could be restarted if needed.

But he also said that, if inflation looked likely to rise above target in the medium term, monetary policy could be tightened.

In his response to Mr King's letter, Mr Darling said the inflation outlook was "subject to some uncertainty" as the world emerges from the "deepest downturn in modern times".

Mr Darling indicated that austerity measures were on the way in the coming years.

He added: "Over the medium term, setting a credible consolidation path to ensure sound public finances is a key element of the Government's macro economic strategy, and it is essential for economic stability and the long-term health of the economy."

January's VAT rise was the biggest factor in forcing the Consumer Prices Index to 3.5 per cent, according to the Office for National Statistics.

The Government reduced VAT to 15 per cent on a temporary basis until last month in an attempt to boost consumer spending and ease the recession, but its return to 17.5 per cent was always expected to have an impact on inflation.

The Office for National Statistics said that, as a result of VAT, the monthly change in the all-item Consumer Prices Index fell by just 0.2 per cent between December and January – traditionally a time when prices fall.

It was the smallest decline since records began in 1996.

Higher fuel and transport costs also sent the prices index up, with annual transport inflation, including the cost of cars, reaching a record 11 per cent.

HOME SALES RECOVERING

The housing market continued to show signs of recovering during December with prices rising by 0.8 per cent, Government figures showed yesterday.

The increase pushed annual house price growth further into positive territory, with prices 2.9 per cent higher than they had been a year earlier, up from an annual gain of 0.5 per cent in November.

But the figures from the Department of Communities and Local Government also showed a slow down in the rate at which property values are rising.

The key three-month-on-three-month growth rate, which is generally seen as a smoother indicator of market trends, eased slightly to 2.9 per cent during the final quarter of the year, down from 3.1 per cent in the three months to the end of September.