The Bank of England may find it difficult to keep inflation on target as long as import and services prices keep rising strongly, Monetary Policy Committee member Andrew Sentance said on Wednesday.
In a speech in London, Sentance said that the economy was facing opposing pressures which the BoE would have to consider when it updated its forecasts for next month's Inflation Report.
"If the headwinds from the financial crisis and the consolidation of public finances dominate the outlook, the balance of risks to inflation are likely to be to the downside," he said, according to the text of his remarks.
"But if the tailwind from the global economy, a competitive exchange rate and a recovery in confidence are felt more strongly, then the margin of spare capacity could be eroded more quickly. In that scenario, there will be more upward pressure on inflation."
Gilt futures edged lower after the comments as markets interpreted them as relatively hawkish, though most analysts expect the BoE will not start raising rates until much later in the year.
"It doesn't take a rocket scientist to guess which of the two outcomes this MPC member favours," said Alan Clarke economist at BNP Paribas.
Speaking a day after figures showed that the British economy crawled out of an 18-month long recession in the last three months of 2009, Sentance said that he did not think a double-dip was likely but noted that the pace of recovery was highly uncertain.
"The pace of any tightening of monetary policy will depend very much on the recovery," he said in a question and answer session after his speech.
In his speech, Sentance also said fiscal policy could be tightened more aggressively after the election or the record budget deficit could act as a bigger drag on the economy.
He said that inflation — which hit 2.9 percent in December, well above the 2 percent target — was likely to rise further in the first few months of the year and while the BoE had predicted this would be temporary, there was now a lot of uncertainty about the outlook.
"While the resilience of inflation is most likely due to the impact of rising import prices, that is not the only possible explanation. Business surveys suggest that the margin of spare capacity within firms is not as high as we might expect," he said.
"At the same time, the increase in unemployment we have seen so far over the recession is considerably less than in the last two major recessions."
