British inflation will peak soon near 5 per cent but remain above the central bank's 2 per cent target well into next year, especially if sterling's fall is sustained, Bank of England Governor Mervyn King said today.
In an open letter to the government published after data showed inflation hit a 16-year high of 4.7 per cent in August, King said the level of interest rates needed to get inflation back to target was "highly uncertain" and he expected to have to write several more such letters in the next year.
The BoE's remit requires the governor to explain publicly to the government if inflation deviates from the target by more than a percentage point and then again every three months if inflation stays out of that band. The BoE last wrote an explanatory letter in June.
Mr King said that on one hand, higher inflation could become entrenched if high energy and food prices spilled over into other costs going up. But on the other, slow economic growth could push inflation below the target in the medium-term.
So far, he said, risks had been balanced, explaining why the BoE had left interest rates at 5 per cent since April.
But the MPC would monitor all developments, including those in financial markets, at its next and subsequent meetings.
Expectations of interest rate cuts have grown sharply this week as global markets are reeling from the news that Lehman Brothers filed for bankruptcy and Merrill Lynch was sold.
But King said the MPC "has become firmer in its belief that a period of muted economic growth is necessary to dampen pressures on prices and wages and return inflation to target in the medium term."
In a written reply, British finance minister Alistair Darling said he agreed with the BoE's assessment of the inflation picture and would continue to support the Monetary Policy Committee in its forward-looking decisions.