He has written to the Governor saying monetary policy in the UK could be used to influence exchange rates and strengthen the pound, insulating us from inflating global commodity prices.
King said on Wednesday that soaring food and fuel prices abroad were in part to blame for the UK’s high inflation but that UK monetary policy held little power to affect this.
But Eve said this is not as true as the Bank might have us believe.
“The Bank of England is trying to create inflation with its policies despite saying it can’t do anything about it,” he said.
“If they raised rates and committed to no further quantitative easing that would make sure we didn’t import more inflation. There’s plenty of economic theory to suggest if you run negative real interest rates then you’re creating inflation.”
The UK is currently running negative real interest rates of 3.7% - the difference between the 4.2% rate of CPI inflation and the Bank Base Rate of 0.5%.
The Bank’s monetary policy objective is to deliver price stability in the form of consumer price inflation below 2% and subject to that, to support the government’s economic objectives including those for growth and employment.
But earlier this week King admitted consumer price inflation could hit 5% this year and claimed there was little the Monetary Policy Committee could do to prevent this.
In his Inflation Report address on Wednesday King said: “The big risks facing the UK economy come from the rest of the world...there is a limit to what UK monetary policy can do when large real adjustments are required. And it cannot influence inflation over the next few months.”
But Eve said if the Bank committed to do no more quantitative easing and began raising rates it would help insulate the UK from global inflation. The reason the Bank isn't, in Eve's opinion, is that inflation helps erode the value of Britian's private and public debt.
In April Eve wrote to Mervyn King outlining these beliefs and has received the following response: “The Bank is still totally committed to meeting its 2% inflation target.
“The Bank’s analysis of factors causing inflation show the increasing standard rate of VAT, energy prices and the impact of past depreciation of sterling on the prices of imported goods and services.
“These factors alone can account for roughly all of the increase in prices over the past year.
“There is no reason to expect another sharp depreciation of the pound and we aren’t going to have another rise in VAT so it seems reasonable to suppose that once the impact of those factors on the 12 month inflation rate dissipates then inflation will fall back.”
LOSS OF CREDIBILITY
Fionnuala Earley, UK consumer economist at RBS, said if the Bank was deliberately creating inflation it would lose credibility in the eyes of the financial markets.
She explained that if the markets believe King can’t keep inflation under control then the UK will have to pay more to borrow as a country. That affects the price we have to pay for loans.
She said: “Mervyn's problem is that if he increases interest rates and hence the exchange rate he risks that the exporters lose out because competitiveness is eroded.
“That's important because markets’ trade has been performing well and helping the UK."
And she added: “Underneath it’s still the same argument: we need to grow to get out of the doldrums. If we cut our deficit quickly with austerity measures which will also bear down on inflation, we will be in a better position and we will be off the radar as far as sovereign debt is concerned.
“But if we do it too quickly we risk damaging the productive potential of the economy so we can’t grow as much full stop.”
NEGATIVE REAL INTEREST RATES
Earley acknowledged that negative real interest rates can be a cause of inflation as people can borrow cheaply and if they spend a lot this pushes up inflation. This is known as domestically generated inflation which Wednesday’s Inflation Report suggested was currently anywhere between -1% and 1%, significantly below the Bank’s 2% CPI target.
She said: “There aren't any signs that this is happening - certainly not in the consumer credit markets and investment isn't taking off either.
“I think it’s perhaps a bit rash to think that the Bank is deliberately causing inflation - that's a big risk.”
Tony Ward, chief executive of Home Funding, also agreed that the Bank had to maintain credibility with the markets and said it was unlikely the current level of inflation was deliberate.
“I don’t believe the Bank of England is deliberately causing inflation,” he said.
“I believe that the Bank recognises that inflation is being caused by factors other than profligacy of consumers and businesses.
“Inflation is going to stall the recovery of the economy and without that it will take much longer to address the deficit and the Bank knows this.
“We can’t grow GDP and become competitive unless people start spending and right now they aren’t because their wages are under increasing pressure from inflation.
“Add to that the economic uncertainty and potential job cuts still to come and they just sit on their hands.
“You can’t just look at one aspect of the economy such as exchange rates and commodity prices but you have to look at the economy and Bank of England as a whole.”
