King forecasts income squeeze as inflation rises

(SHARECAST) – Britain faces the tightest squeeze on household budgets since the 1920s, Bank of England governor Mervyn King warned last night.

His comments came just hours after shock government statistics that showed the UK economy contracted by 0.5 percent in the three months to December.

“In 2011, real wages are likely to be no higher than they were in 2005,” King said. “One has to go back to the 1920s to find a time when real wages fell over a period of six years.”

“The squeeze on living standards is the inevitable price to pay for the financial crisis and subsequent rebalancing of the world and UK economies,” he said in a speech in Newcastle.

King predicted inflation would rise to between four percent and five percent, more than double the bank’s two percent target.

He added that the economy’s 0.5 percent contraction in the fourth quarter highlighted the “choppy” nature of the recovery but defended the current austerity strategy.

“Of more immediate concern to the MPC [the BoE’s interest rate committee] is that we are experiencing uncomfortably high inflation.”

It was a misapprehension that the MPC “could have prevented the squeeze in living standards by raising interest rates over the past year to bring inflation below its present level. That view is a misunderstanding of how monetary policy works,” he said.

“Inflation might well have started to fall back this year, but only because the recovery would have been slower, unemployment higher and average earnings rising even more slowly than now. The erosion of living standards would have been even greater.”

The economic weakness revealed yesterday justified the decison to keep interest rates low and to maintain the £200bn quantitative easing programme, he said, adding that the UK economy was “well placed for a return to sustained, balanced growth”.

“The right course has been set and it is important to maintain it,” he commented.