The Bank of England Governor Mervyn King has said the the pinch on UK pay is necessary.
King said that the high inflation rate we are currently facing was necessary while the UK economy adapts to higher priced commodities and becomes more competitive.
The Governor also announced that a rise in the rate of inflation to 4-5% is likely in the next quarter, but this will fall sharply in 2012
He also portrayed that the Bank of England will thwart attempts by wage-setters to keep up with the above-target price rises.
“Further rises in world commodity and energy prices cannot be ruled out,” he said.
“Attempts to resist their implications for real take-home pay by pushing up wages would require a response.”
Despite Mr King’s stern warning – which come only days after news of the economy slowed by 0.5% in the last quarter of 2010 – he did give the impression that the Bank wasn’t looking to raise the interest rates in the immediate future.
Mr King states that the rising prices, lagging wages, high existing debt levels, high interest rates from banks and the lack of money borrowed is the cause.
He blamed the high inflation rate – which rose to 3.7% in December, well above the Bank’s 2% target – on three factors:
- higher import prices thanks to the weak pound, which is needed to make the UK economy more competitive
- rising energy prices and other commodity prices, such as cotton, food and metals, driven by growing demand from the developing world
- rises in VAT, as the government begins to stabilise its finances
According to Mr King these are all necessary in order to re-establish the UK economy away from domestic spending to exports – a process that he claims is already underway.
The Bank also noted that the lack of movement in UK wages when combined with high inflation has equalled the longest decline in the real value of after tax wages in the UK since the 1920′s
Nonetheless, Mr King claimed that hard times for UK wage-earners were, one way or another, inevitable.
He added that if the Bank were to counteract rising commodity prices by rising interest rates, this would simply lead to the same eventuality of lower wages – but at a negative effect leading to a deeper recession.
“Monetary policy can affect the inflation rate at which these adjustments take place,” he said.
“But it cannot alter the fact that, one way or another, the squeeze in living standards is the inevitable price to pay for the financial crisis and subsequent rebalancing of the world and UK economies.”