Bank of England boss Mervyn King warned that grim GDP figures serve as a stark reminder that Britain’s recovery will be “choppy” as he braced consumers for a bleak year ahead.
In a speech at Newcastle’s Civic Centre on Tuesday night, the Bank Governor said Britons should expect inflation to rise to between 4% and 5% over the next few months.
It concluded a gloomy day in which it was also revealed that the UK economy unexpectedly shrank in the fourth quarter
A shock 0.5% plunge in gross domestic product (GDP) between October and December was blamed on severe weather last month which triggered a drop in demand for the key services sector, which makes up more than 75% of the economy.
Analysts warned the surprise decline – the first since the third quarter of 2009 – seriously damaged prospects for the economy as it takes the strain of the Government’s sharp austerity measures. It also raises the prospect of stagflation – a period of high inflation coinciding with a stagnating economy.
On Tuesday night, Mr King warned that real wages will plunge back to 2005 levels as prices soar and the Government’s deficit-busting actions take effect. And while the economy was “well placed to return to sustained, balanced growth”, Mr King outlined strong headwinds facing the economy in 2011.
Rising unemployment and declines in real earnings will hit spending in the private sector, with the public sector hammered by Government spending cuts.
But it was inflation that was the Governor’s biggest immediate headache. He told the accountants’ business dinner that the latest GDP figures “remind us that, as I said last year, the recovery will be choppy. Of more immediate concern to the Monetary Policy Committee is that we are experiencing a period of uncomfortably high inflation.”
He added: “With the standard rate of VAT rising to 20% this month, and recent further increases in world commodity and energy prices, inflation is likely to rise to somewhere between 4% and 5% over the next few months, before falling back next year.”
His move to increase Bank inflation expectations yet again will heap further pressure on the MPC. There have been calls for action after inflation rose to 3.7% in December, far higher than the Bank’s 2% target.