Living standards will not rise for a year, warns King

By Sean O'Grady, Economics Editor
Friday, 27 June 2008

In a stark warning of hard times ahead, the Bank of England's Governor told MPs yesterday that there will be no growth in living standards for a year.

Giving evidence to the House of Commons Treasury Select Committee, Mervyn King warned that the normal improvement in the standard of living that families had become accustomed to would be subject to a "one-year pause".

Household budgets would be squeezed by the rapid increase in the cost of fuel and food, he said, while income growth would be constrained by the downturn in the economy. Borrowing for property purchases, consumption and investment would be made more difficult by thecredit crunch, because banks were still reluctant to lend,Mr King said.

There was "no magic bullet" to shield the economy from the effects of a global rise in commodity prices, he added, and people had to be persuadedthat "facing up to reality" was preferable to trying to secure higher wage settlements in a vain attempt to protect their standards of living. In a thinly veiled warning to unions, Mr King said the cost of winning higher pay awards would be a "very prolonged and deep slowdownin activity".

He told MPs that inflation was "likely to rise further this year", to beyond 4 per cent, although the actual peak would depend on how much domestic gas and electricity tariffs increased. The relatively hawkish tone of his remarks helped to push the FTSE 100 share index down by more than two per cent. Most analysts, however, took the view that an early rise in interest rates remains unlikely.

In his Mansion House speech last week, Mr King hinted that the Bank's Monetary Policy Committee would be willing to raise interest rates if that was necessary to dampen inflationary expectations, which have been rising, and to prevent an inflationary psychology taking hold in the labour market. Yesterday, the Governor warned: "If a continued rise in oil and food prices was feeding through to longer-term inflation, we would have to take action".

Paul Tucker, the Bank's executive director for financial markets, told the committee: "If we were to let the inflationary genie out of the bottle, we would end up aggravating the slowdown because we would have to tighten monetary policy to put the genie back in the bottle. All the experience of the past shows that that is actually quite a difficult and quite a horrid thing to do."

Nor did Mr King have much encouraging news for homeowners. During his testimony, he predicted a period of "extremely weak activity" and added: "None of us can really know where house prices will go. We are going through a period of adjustment now in which, because any prospective purchaser cannot really judge the likely level of house prices and where they will settle, it would be a very natural response to pull back and to wait until the market has reached a new equilibrium before coming in."

Reflecting on the boom in commodity prices, Mr King thought some of the blame lay with the policies of China and other fast-growing Asian economies whose currencies are linked to the US dollar. "That has caused difficulties and, in the current circumstances, what it is doing is leading that part of the world economy to have a much more expansionary monetary policy than would be desirable," he explained. "I have no doubt that that is one of the factors that has lain behind some of the upward pressure on commodity prices, in addition to issues to do with the balance between demand and supply."



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