Mervyn King, Governor of the Bank of England has warned that Britain faces the possibility of higher inflation and rising unemployment.

UK inflation rates are amongst the lowest within the EU since the start of 2000. The Consumer Price Index (CPI) inflation rate in the UK fell to 1.1% in September, a figure which is well below the Bank of England’s target rate of 2% but despite this King has said that there, ‘is no time for complacency or hubris’ over inflation.

In a speech delivered to the Eden Project, Cornwall Mervyn King offered three possible explanations for why inflation has not risen so far despite a substantial fall in unemployment and spare capacity.

Explanation 1

• Reforms over the last 25 years have made the labour market more flexible and lowered the rate of unemployment




• Incentives to work have increased




• Benefits paid to the unemployed have fallen relative to earnings




• The share of wage settlements covered by collective bargaining has fallen sharply




• Migrant labour is relieving shortages

Explanation 2

• An increase in the pace of productivity improvement may have made it possible for output to grow more rapidly without adding to inflationary pressure




• Productivity growth in the private sector was higher in Britain that in the US for most of the past quarter of a century, although our level of productivity remains inferior




• It is possible that the effect of productivity improvements, especially the temporary boost to profits, was obscured by the impact of the rise in sterling since 1996 and by global competition which have lowered prices and compressed margins

Explanation 3

• The new monetary policy framework has helped to anchor inflation expectations to the target




• As a result, a surprise movement in inflation is expected to be temporary and so less likely to lead employers and employees to adjust their desired prices and wages

King commented:

“The combination of low and stable inflation and continuously falling unemployment must come to an end at some point, and may already have done so. Starting as we do now, with little if any spare capacity, it is unlikely that we can expect unemployment to fall indefinitely.

“From time to time shocks will hit our economy, as we have seen with oil prices and world trade, and so there will be fluctuations in growth and unemployment, as well as in inflation. Unemployment can be maintained at lower rates that in the past, even though there will inevitably be times when it will rise because no monetary policy can help to prevent all fluctuations of demand, output and hence employment.”

Official labour market statistics out today show that the unemployment rate continues to fall. In the last quarter it dipped by 51,000.

Dr John Philpott, chief economist at the Chartered Institute of Personnel and Development (CIPD), however, says the figures hide a weaker demand for staff and a cooling labour market.

Commenting on the findings Dr Philpott said:

“Today’s official figures confirm that the UK job market is now at a virtual standstill. The flood of new jobs enjoyed in recent years has slowed to a trickle. And with the number of economically inactive people of working age at a record level, the government is still a long way short of meeting its goal of ‘full employment in an opportunity society.’

“Despite continued good news on measured unemployment hardly any net new jobs have been created this year and the employment rate for people of working age has fallen to 74.7%. The slowdown is even more marked in terms of hours worked – a further fall of 4.2 million hours per week in the latest quarter.”