King sounds relaxed on inflation

by Ed Bowsher on 21 October 2009  |  1 comment
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Mervyn King doesn't appear to be too worried about inflation. That suggests the base rate will stay low next year.

Yesterday's speech by Mervyn King - Governor of the Bank of England - has generated plenty of coverage, most of which has focused on his desire to break up large banks. That's important stuff, but his comments on inflation are also noteworthy. In particular, this bit:

'It is likely that inflation will remain volatile over the coming year. It will pick up over the next few months reflecting higher petrol prices, recent falls in sterling, and the reversal of the cut in VAT. Looking through these short-run factors, however, inflation will be determined by the path of money spending relative to the supply capacity of the economy. Over the past year money spending, which normally expands at around 5% a year, has fallen by 5%. That is already pulling down on inflation and will continue to do so until spending recovers.'

In other words, the amount of money that is flowing around the economy, and which is being spent, is low. When that happens, many economists would expect inflation to be low for the following period. By focusing on this point, King is suggesting that he is not worried that inflation is set to soar in the near future. And if inflation isn't set to soar, we probably won't see dramatic rises in the Bank of England's base rate in 2010.

Of course, you can never be certain about these things. Especially after one of most serious financial crises in history. But King's comments strengthen my view that interest rates will probably stay low for a while to come. That's good news for borrowers - especially those on variable rate mortgages - but not so good for savers.