King warns of budget squeeze

Updated 22.34 Wed May 14 2008

Keywords: Bank of England, Mervyn King

The Bank of England Governor has braced households to expect a further budget squeeze.

Mervyn King warned over the impact of soaring energy bills, food prices and dearer imports as the Bank's latest forecasts predicted inflation could spike as high as 3.7 per cent this year.

"As those price increases feed through to household bills, they will lead to a squeeze on real take-home pay, which will slow consumer spending and output growth, perhaps sharply" - Mervyn King

"As those price increases feed through to household bills, they will lead to a squeeze on real take-home pay, which will slow consumer spending and output growth, perhaps sharply," the Governor said.

The Bank has predicted growth could slow to just 1 per cent this year - well below official Government forecasts - as banks hit by the credit crunch tighten up lending and consumers save more.

Wages are meanwhile unlikely to grow significantly as businesses come under pressure and shed jobs.

But policymakers are unlikely to ride to the rescue of struggling homeowners and borrowers with a swathe of interest cuts because inflation is so high.

The Bank's Monetary Policy Committee (MPC) is charged with keeping inflation at 2 per cent, but CPI is likely to remain above 3 per cent until well into next year - prompting a series of open letters from Mr King to the Chancellor explaining the rise.

The report suggests Consumer Prices Index (CPI) will remain well above its 2 per cent target in two years' time if rates fall up to twice more this year to 4.5 per cent as markets expect.

Jonathan Loynes, chief European economist at Capital Economics, said: "The report suggests that the MPC will not deliver the rate cuts which the news on the economy suggests are sorely needed.

"We still think interest rates will eventually fall, but a June cut now looks pretty unlikely and any further loosening will be modest in the foreseeable future - seriously bad news for the economy."

Mr King said the economy was "travelling along a bumpy road" and called for patience until inflation returned to target.

But he also admitted that uncertainty over oil prices and the timing of price hikes from energy companies made it "extremely difficult" to assess the situation accurately.