As Chart 11 shows, we have seen two major spikes in CPI inflation within the last two years. And it is possible that another one is in prospect when higher VAT comes into effect early next year, particularly if this is accompanied by a continuation of the recent surge in energy and commodity prices. These repeated episodes risk eroding confidence that UK policymakers remain committed to low and stable inflation, with a knock-on effect on inflation expectations in financial markets, among the business community and the public which could be self-fulfilling. In the depth of the recession in the first half of last year, we could be fairly relaxed about upward pressures on inflation. At that time, the MPC was worried about the opposite trend – a lurch into deflation with prices and wages on a downward spiral. But these deflationary fears have not been realised. Instead, inflation has run above the target and wage freezes introduced to help businesses weather the storm of the recession are coming to an end. The current period of above-target inflation risks being prolonged by monetary policy which is too lax – creating a climate in which higher inflation is not just the product of one-off shocks but becomes more deeply ingrained. 12  BIS Review 134/2010  The economy is now recovering at home and abroad. The world economy is growing above its pre-crisis trend, and domestic spending in money terms is also following the same pattern, as Chart 12 shows.
5  The latest evidence suggests that the strong momentum of growth in Asia and other emerging markets is being maintained. In Asia, there are many indications that domestic demand has been a powerful driver of its recovery and that growth in this region is becoming more autonomous and less dependent on export demand from the western economies. In the US and Europe, the indicators are more mixed. Within the European Union, Germany grew very strongly in the first half of this year, recording the biggest rise in GDP since unification in the second quarter and more recently the lowest rate of unemployment since 1992. German unemployment has been falling since the mid-2000s, with the exception of the recession period, which points to an improvement in the structural performance of its economy, which should help to sustain consumer spending and investment. Some of Germany’s neighbouring economies – including the Benelux countries – are also sharing in this pattern of healthy growth. A strong performance from these “core” European economies should help to offset the dampening effect of financial and fiscal problems in countries on the European periphery, including Ireland. 5  In the decade to 2007, annual GDP growth averaged 3.1% in the United States and 2.3% in the European Union. BIS Review 134/2010  5  Currently, the United States appears to be in a “soft patch” where growth is disappointing. But the most recent indicators – including the widely followed Purchasing Managers’ Indices (PMIs) – still point to continued growth.