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King: Most challenging economy in 20 years

19/06/2008

The UK faces "the most difficult economic challenge for two decades" Bank of England governor Mervyn King said in a speech last night.

In his Mansion House speech to senior City figures, Mr King said the monetary policy committee (MPC) "is prepared to take whatever action is needed to return inflation to the two per cent target", raising the possibility that the interest rate could be going up.

The Bank of England will continue to target inflation, not growth, the governor emphasised.

"We are in the most challenging period since the MPC was set up in 1997," Mr King said.

The speech followed Alistair Darling's first Mansion House address, which focused on inflation and regulation of the financial markets.

Mr King warned the next year would be a difficult one, and the NICE decade – non-inflationary consistently expansionary – is over.

On Tuesday, consumer price index (CPI) figures were published showing inflation has now hit 3.3 per cent and Mr King warned it would continue to rise over the next few months.

Higher food and energy prices, which are driving inflation, will be "an even more significant restraint on consumer spending this year than the credit crunch," Mr King warned.

But although commodity prices will push up inflation in the short term, it will not be enough in itself to generate sustained inflation.

"That means that the rate of increase of other prices and domestic costs, notably pay, must remain low," Mr King urged.

Turning to property, the governor said lower demand in the high street will go hand in hand with lower demand in the property market.

In addition, the era of cheap mortgage finance that underpinned the housing market in 2006 and the first half of 2007 is over. As a result, it is reasonable to expect the ratio of house prices to incomes to fall back, Mr King said.

Mr King also welcomed announcements by the chancellor relating to the Banking Bill and reforms to the Bank of England, including the introduction of a proper process for appointing members to the MPC.