The British economy is slowing but price pressures are on the rise, and policymakers need to be alert to both risks, Bank of England officials said this afternoon in a sign that interest rates will come down only gradually.
A Confederation of British Industry survey encapsulated the central bank's dilemma, showing retail sales posted an annual fall this month but stores planned to ramp up prices at their fastest rate in 12 years.
Business investment, meanwhile, fell at its sharpest rate in three years in the last three months of 2007 as construction spending shrank, according to an official survey, probably as companies hunkered down for a slowdown in the property market.
Slowdown or not, soaring food and energy prices mean people expect prices to keep rising at a rate well above the central bank's 2 per cent target, according to a YouGov/Citigroup survey, also out today.
"Policy needs to balance two significant risks - first, that financial stress will precipitate an unduly sharp slowdown in demand," BoE Deputy Governor Rachel Lomax said in a speech. "And second, that temporarily high inflation will lead to inflation expectations persisting at too high a level."
Fellow Monetary Policy Committee (MPC) member Tim Besley also struck a similar note in an interview with the Daily Mail newspaper on Tuesday in which he said he was "largely agnostic" on what the greater risk was.
One of the most hawkish members of the MPC, Besley said a period of weaker consumer spending and house price stagnation might be necessary to rebalance the economy.
Finance minister Alistair Darling, speaking today two weeks before his first budget, said the economy was still resilient and well-placed to cope with the global slowdown.
He said there was leeway to boost growth and that fiscal policy was ready to support monetary policy, in a sign that the government appears happy to let automatic stabilisers work as the economy slows, regardless of the budgetary position.
Most economists do not expect significant fiscal loosening in the budget on March 12th given that Darling will probably want to get closer to election time - it must take place by May 2010 - before pulling any massive crowd pleasers.
They do, however, predict further cuts in interest rates - another quarter-point reduction to 5 per cent is expected by the middle of the year.