In each letter, Mr. King named a different set of one-off events, including a drop in the pound and higher commodity prices, as the reason for inflation and predicted that the effects of a weak economy would push inflation lower. But after two years, some economists are questioning whether there is not more to the persistence of the inflation rate, which was at 3.4 percent in May.
“It’s noticeable that the U.K. is growing in the opposite direction of the U.S. and the euro zone,” said Danny Gabay, a director at Fathom Financial Consulting in London and a former author of the Bank of England’s inflation report. “Economic growth surprised on the downside and inflation on the upside. That’s a very uncomfortable position to be in.”
Britain’s economy grew 0.3 percent in the first quarter, helped by growth in manufacturing.
Persistently higher inflation rates could limit the Bank of England’s ability to keep interest rates low to allow for a more stable recovery, some economists said. The bank, which has a mandate to keep inflation low, is expected to keep interest rates unchanged at 0.5 percent on Thursday.
The bank previously said that it was “very concerned about what’s been happening to inflation” and “how resilient inflation has been,” especially against the background of a recession.
It named three main factors as causing the higher rate: Oil prices were on average nearly 80 percent higher than at the beginning of 2009; the government restored a 17.5 percent sales tax in January after cutting it to help consumers; and a 26 percent drop in the pound against the dollar in 2008 drove prices higher.
Some economists disagreed, however. Higher commodity prices were not unique to Britain, and the euro also slumped against major currencies, albeit recently. Economists also pointed out that price increases were especially strong in the service sector, pushing up the cost of items like insurance, which are not directly related to currency exchange rates.
“The inflation issue recently has been higher levels of service sector inflation,” Stuart Green, chief British economist at HSBC in London, said. “That’s very unique to the U.K.”
The inflation rate also generated a debate within the Bank of England. Charles Bean, the deputy governor, said a lack of lending by banks might have made companies more concerned about cash flow and less willing to cut prices than in previous economic downturns.
Another member of the monetary policy committee, Adam Posen, in a speech last month blamed expectations of inflation for rising consumer prices. Mr. Posen argued that the Bank of England’s previous decisions to keep interest rates at a record low even as inflation crept up led consumers to expect that inflation would remain high for a while.
Expectations of higher inflation usually prompt companies to increase prices and workers to push for higher wages.
“The most logical and empirically reasonable explanation for inflation creep is some unanchoring of inflation expectations caused by a series of above-target outcomes for U.K. inflation in recent years,” Mr. Posen said.
But Hetal Mehta, an economist at the Ernst & Young ITEM Club economic forecasting group, said that while there was evidence that some companies had increased prices or kept them steady, there was little indication that workers were asking for higher pay. Since 610,000 public-sector jobs are to be cut by 2016 under the government’s austerity program, that is not likely to change.
Still, concern among some economists is mounting that Bank of England policy makers might feel pressed to raise interest rates because of inflation, even if the economy has not recovered fully. Those economists fear that increasing rates too soon could push the economy back into a recession.
Andrew Sentance on June 10 became the first committee member to vote for a rate increase in almost two years. Dr. Sentance later told Reuters that he was concerned about inflation expectations and said he would prefer “gradual” interest rate increases.
Mr. Sentance also raised doubts about the strength of existing deflationary pressures, hinting that prices might continue to rise because more companies than initially thought went bankrupt and the supply of products suffered.
Despite disagreements about the roots of higher consumer prices, many economists expect the Bank of England to keep interest rates unchanged until at least next year. The government’s austerity program, which includes a sales tax increase to 20 percent next January, means inflation could remain volatile.
“They should sound worried about inflation but also be mindful that there is a bigger danger, and that’s to increase rates when the economy is still low,” Mr. Gabay said. “If both consumers and the government save, things can turn ugly very quickly.”