Bank of England still on horns of inflation dilemma

The Bank of England may face an increasing monetary policy dilemma at a time of economic stagflation that hits indebted consumers hard.

Yesterday (May 10th) saw the Bank of England announce its monthly Monetary Policy Committee decision. As usual, it held the base rate at 0.5 per cent, while keeping the asset purchases at £325 million, a figure it has not increased since February.

The decision may have been predictable enough, but it could also reveal a growing dilemma faced by the MPC, with significant consequences for consumers struggling to pay off their debts at a time when the first quarter gross domestic product (Q1 GDP) figures indicated Britain is back in recession.

Consumer economist at the Royal Bank of Scotland Fionnuala Earley outlined the problem, commenting: "Even though inflation is higher than the Monetary Policy Committee would like, it has to take very seriously the risk that weak Q1 GDP numbers and yet more turbulence in the Eurozone could be catalysts for below target inflation, and growth, in future."

This means that on the one hand, the bank cannot risk raising interest rates to try to curb inflation that has remained persistently above target – and rose in March after five successive monthly falls – without further depressing an economy that is contracting again, at least according to the Office for National Statistics' initial estimate.

And on the other, the Bank may find further quantitative easing a problem as increasing the flow of money into the economy could further fuel inflation, while at the same time not doing so could remove a much-needed source of stimulus.

A situation where inflation is rising while an economy declines is termed stagflation and if this persists over the coming months, it may hit consumers hard.

Any failure of inflation to fall back to its target level over the coming months as predicted in the Bank's most recent Quarterly Inflation Report could mean it is harder than ever to find the cash to pay off debt while also meeting other living costs.

And at the same time, recession could mean job losses and people with debt might find the income they rely on to pay what they owe suddenly vanishes.

The next Quarterly Inflation Report is due out next week and commentators may be keen to know if the MPC believes inflation will manage to drop in the months ahead without a continuing shrinkage of GDP.

By Joe White