But the risk of inflation staying above the target into the medium term needs to be weighed against the downside risk to growth and the prospect of a persistent margin of unused resources in the economy. Allowing inflation to come back gradually towards the target would allow the margin of spare capacity to close more rapidly, and would be in line with our remit that tells us that temporary deviations of inflation from the target are permissible if they help to avoid excessive volatility in output. I hope my remarks today have given you some insight into the issues that the MPC is presently grappling with. You will be aware that the spread of opinion on the Committee is unusually wide right now. That is in large measure a reflection of the substantial challenges and uncertainties facing the UK economy at the current juncture. Indeed, given the extreme nature of recent events, it would be surprising if the Committee were entirely at one in its assessment of the outlook and its judgement of the appropriate policy response. But the Committee is united in its objective of meeting its inflation mandate in the medium term and playing its part in restoring the economy to a high and stable level of activity. Thank you!
In terms of the outlook, a key issue that the Committee faces in deciding the appropriate stance of policy is the extent to which the current elevated levels of inflation will persist into the medium term. Our most recent projections, conditioned on market interest rates, existing fiscal plans and the futures prices of commodities, are shown in Chart 10. The central view is for inflation is to rise further in the near term as recent commodity price increases pass through, but then to fall back, particularly in 2012 as the rise in VAT to 20% drops out of the twelve-month comparison. It then continues to ease back, reflecting the continuing – though uncertain – drag from the margin of spare capacity in the economy. A number of factors will determine the rapidity of that return to target. Profit margins have been squeezed during the recession and businesses are likely to want to rebuild these as the recovery proceeds. But the real purchasing power of wages has also been severely squeezed and employees may also seek to recoup some of that. Ultimately this is about how the costs of the recession and the deterioration in the terms of trade associated with higher real import costs are shared out 7 , but during the adjustment phase it may be manifested in temporarily higher wage and price inflation. Consistently above-target inflation, whatever its cause, may also lead people to believe that it will remain high in the future.