The third, and most important, question is about inflation. Why has it picked up so sharply over the past year? Are those changes temporary or more persistent? The recent rise in inflation to over 3% does look temporary. The pickup in the months leading up to March this year reflected in part a rise in domestic gas and electricity prices. And the fallback in inflation which has already begun, and which is likely to continue for several months, is in part the result of cuts in domestic gas and electricity prices which have already been announced. Those shocks are relatively easy to identify. But it is much harder to know where inflation would have been without them. Sharp rises in the prices of energy and food have squeezed spending on other goods and services, putting downward pressure on those prices. That is why measures of “core inflation” that strip out certain prices can be highly misleading. Even accounting for the temporary influences, more persistent inflationary pressures have picked up. Some of that stems from the shocks to demand and credit supply that I described earlier. And against that background, expectations of inflation over the next year, on which price and wage decisions are based, have drifted up. That is the third reason why the MPC has raised Bank Rate. Those are the shocks we have spotted. A boost to supply from inward migration has not compensated for a positive shock to both domestic and overseas demand.
The complexity of such a process means it is necessary to design forthwith efficient exit strategies, so that they may be implemented when the time is right. The euro area also shares, albeit to a lesser extent than other zones, these signs of incipient improvement. The latest economic data have been less adverse than expected and the quantitative and qualitative indicators coming to light point to a stabilisation of activity in the very short term which, according to the ECB's projection exercises, will be followed by a presumably slow recovery that will not be free from difficulty. Public finances have deteriorated considerably as a result of the operation of the automatic stabilisers, the discretionary measures to stimulate aggregate demand and action to shore up the financial system. In turn, the financial crisis and the fall-off in activity have severely affected certain European banks, which depend in part on public sector support and which remain subject to a deleveraging process whose scope is still not readily discernible. On the prices front, the risks of deflation have diminished substantially. Although the strong easing in commodities prices until mid-year meant that inflation turned negative, there is a broad consensus, of which the ECB is part, that anticipates inflation will resume positive levels towards the end of the year. Such levels would, however, be moderate for a relatively lengthy period, against a background marked by considerable slackness in productive capacity which will help contain potential inflationary pressures.