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Sir Mervyn King Warns 3% Inflation, Or More, Will Be Seen This Summer, And GDP Growth Is Limited

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Inflation is expected to rise to at least 3% by the summer and will remain above the 2% target for at least two more years, forcing more pain on struggling household finances.

Bank of England governor Sir Mervyn King said weak productivity had kept inflation stubbornly high, with increases in domestic energy bills named as a key driver behind the trend - both of which he referred to as "self-inflicted own goals".

Much of the higher inflation was also blamed on the weakness of sterling, and rises in prices partly set by the government such as tuition fees. Sir Mervyn said it was now "appropriate to look through the temporary, albeit protracted, period of above-target inflation".

Presenting the Bank of England's quarterly inflation report, he desperately tried to suggest a "recovery is in sight", mentioning it three times in the opening lines of his speech, but warned the path ahead for the UK economy will not be smooth.

Stubbornly high inflation - which has remained unchanged for four consecutive months for the first time since records began in 1996 - is causing problems for policymakers as they also weigh up the risks to the economic outlook.

At a time when very few people have received anywhere near a 3% pay rise, the continued squeeze on people's wallets will do little to encourage greater domestic spending.

Last week, the Bank held off from more money printing measures, keeping its quantitative easing (QE) programme at £375 billion, while it also kept interest rates at 0.5%.

Sir Mervyn took the opportunity today to stress that turning the taps on further and tinkering with monetary policy would not help the UK out of recession.

"Attempting to bring inflation back to target would risk derailing the economy and below target inflation in the medium term," he said.

"We need to find a way of boosting products to overseas markets. There are limits to monetary stimulus... if we are to see a return to stability, the world economy must find a new equilibrium which balances the world's demand."

The strength and sustainability of any UK recovery will rest on a few factors, the BoE reported: the extent to which households and companies have already adjusted to the impact of the financial crisis; the degree to which productivity and expectations of future supply pick up alongside demand; the impact of fiscal consolidation; and on whether the recent easing in credit conditions continues and prompts higher lending to the real economy.

Sir Mervyn's depressing speech arrives on the back of a report by the Resolution Foundation, which predicted that millions of families might not see see a return to pre-recession standards of living for another decade.

Many low to middle income households would never fully recover the ground they lost due to the prolonged economic downturn, and even if typical earnings for such families were to rise by 1.1% a year, the report calculated that would take until 2023 before they recovered to £22,000 a year at current prices - the equivalent of where they stood in real terms in 2008.

Without the prolonged downturn, the report estimates that typical earnings could now be expected to stand at £27,500 a year.

However to reach that level over the next decade would require real terms growth of 3.3% a year - figure the report described as "unattainable" based on current forecasts and past experience.

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