King confident on inflation fall

Mervyn King tells MPs about the outlook for inflation

The governor of the Bank of England, Mervyn King, has told MPs he is confident that inflation will fall back to the government's 2% target.

However, he warned that before price growth slowed, the rising cost of food and energy prices were likely to push inflation above 4% this year.

Mr King said an economic slowdown was needed to ensure inflation returned to the goal in the next year or so.

He added that the Bank would "ensure" that inflation slowed to target levels.

Mr King was appearing before the Treasury Select Committee a week after he wrote to the chancellor, explaining why inflation had hit 3.3%.

Last week, he said the UK faced its "most difficult economic challenge for two decades".

Higher interest rates would be needed as a result, Mr King added, but he did not commit himself to any particular level.

House price speculation

Oil prices - which came close to $140 a barrel earlier this month - were now higher in than the 1970s in real terms, he told MPs, while the depreciation of sterling had made imports more expensive.

"This will pass through to household bills and consumer prices," he said.

The removal of the erroneous belief that house prices will only ever grow in real terms is not a bad thing Kate Barker, MPC member

The comments followed last month's Mansion House speech where he said that growth and house prices were likely to fall and that real take-home pay would stagnate, making life difficult for some families.

The Office for National Statistics (ONS) said the Consumer Prices Index (CPI) rose by 3.3% in May, up from 3% in April.

This is the fastest rate since the CPI measure began in 1997, the ONS said.

The wider Retail Prices Index measure of inflation rose to 4.3% from 4.2% the previous month.

'Pull back'

On the housing market, Mr King said that the situation was very different from the troubles of the early 1990s - with levels of people in arrears and the number of repossessions much lower today.

But he forecast a "period of extremely weak activity" in the housing market as people took stock of what was happening to prices.

"None of us can really know where house prices will go," Mr King said.

"We are going through a period of adjustment now, in which, because any prospective purchaser can't really judge the likely level of house prices and where they'll settle, it would be a very natural response to pull back and to wait until the market's reached a new equilibrium before coming in."

What would happen was "difficult to predict", he added, though said the situation had to be monitored.

Bad thing?

Another member of the Bank's Monetary Policy Committee, Kate Barker, told MPs that while a fall in house prices was not, in the short term, good news, it had served a useful purpose.

"There was an element of speculation in the market, especially in buy-to-let," Ms Barker said.

"So the removal of the erroneous belief that house prices will only ever grow in real terms is not a bad thing."

She added that the market correction was different from the 1990s, when there had been "a much faster slowdown in the economy as a whole and a much greater rise in unemployment".

But she said that there were worrying signs in the construction sector, which had seen a fall this year "that it took almost six years to achieve in the 1990s".