Page last updated at 11:52 GMT, Friday, 16 May 2008 12:52 UK

CPI target to 'crucify' consumers

Shot of the Bank of England
The Bank of England is having problems controlling inflation

Consumers will be "crucified" unless the government changes its inflation target, a leading economist has warned.

Peter Spencer from the influential Ernst & Young Item Club is urging ministers to change the 2% inflation target used by the Bank of England.

He warned that interest rates would have to stay at 5% if inflation is to be brought down to 2%.

He added that keeping interest rates at their current level would hurt hard-pressed households.

With annual inflation at 3%, the Bank has little room to cut borrowing.

March's 0.8% monthly rise in consumer prices was the steepest for nearly seven years.

Moving targets

Bank of England Governor Mervyn King has said its rate-setting body, the Monetary Policy Committee, is facing its "most difficult challenge" with inflation rising and growth weakening.

It is required by government to focus on stopping inflation getting more than one percentage point above or below its 2% target, but Mr King has warned that this condition is unlikely to be met for the foreseeable future.

The Chancellor should have a very good look at the specification of monetary policy
Peter Spencer, chief economic adviser, Ernst & Young Item Club

Professor Spencer said consumers were paying the price for an inflation target that had become unrealistic given the volatility of oil and food prices.

"The consumer will have to be crucified in order to meet the inflation target as it stands at the moment," Professor Spencer, who sits on a panel of economists known as the "Shadow MPC", told the Daily Telegraph.

"If we stick with the current remit we will need to keep interest rates at or about 5% for a good 12 months to get inflation back on track."

"There is a very big 'if' there. The chancellor should have a very good look at the specification of monetary policy."

Since 2003 the government has used the consumer price index (CPI) as its inflation benchmark that, in turn, is used by the MPC.

Leaving rates where they are now for the foreseeable future would further squeeze household incomes and force companies to cut jobs, Professor Spencer warned.

He called for the Bank of England's remit to change so it focused on "core inflation", a measure that excludes food and energy prices and is used in the US.

"The point is to nail your colours to a mast that you can actually control rather than house and energy prices which you cannot."

Critics of this approach say excluding food and fuel costs from calculations would be absurd since they account for such a large slice of household budgets.

Mr King has warned that the economy is facing a "bumpy" period over the next year during which growth will slow markedly yet inflation remain well above target.

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