King made the claim today in an open letter to Chancellor George Osborne.
“Several member countries face substantial challenges in ensuring the sustainability of their fiscal positions and preserving the stability of their banking systems,” he said.
“There is a risk that this could lead to further severe stress and dislocation in financial markets and were this risk to crystallise, it would have a significant impact on the UK economy.”
King was forced to write his seventh letter to the Chancellor today after inflation hit 4.4%, keeping it more than 1% above the Bank of England’s 2% target for more than 18 months.
“Every member is determined to adjust the degree of monetary stimulus as required in order to return inflation to the target in the medium term, mindful of the risk of generating undesirable volatility in output by attempting to bring inflation back to the 2% target too quickly,” King added.
At the August meeting the Monetary Policy Committee kept Bank Rate at 0.5% and the stock of purchased assets financed by the issuance of central bank reserves at £200 billion.
King reiterated last week’s inflation report findings in today’s letter, citing the increase in the standard rate of VAT to 20% and past increases in global energy prices and import prices as factors causing inflation.
He said: “Although it is impossible to identify the effects of those factors with precision, it is likely that inflation would be below target in their absence.
“It is likely that inflation will rise to around 5% in the coming months, boosted by increases in utility prices, and reflecting the continuing effects of the temporary factors described above.”
King said inflation should then fall back through 2012 as those effects dissipate and downward pressure from slack in the labour market persists.
He admitted that the Bank couldn’t be precise about the timing and extent of that fall calling it “highly uncertain”.
