pressure on inflation from the subdued level of demand. nevertheless, given the expected degree of spare capacity in the economy over the next few years, and that the temporary factors should wear off, the most likely outcome is that inflation falls back to below target over the next couple of years as shown in the may inflation report ( chart 12 ). on that basis it was sensible not to try and offset the recent rise in inflation by tightening policy. but let me be clear about the risks. our central expectations could be wrong. certainly the inflation data have tended to consistently surprise on the upside, month - by - month. what if spare capacity continues to exert much less restraint on inflation than anticipated? or perhaps current data estimates have significantly underestimated demand and output growth? or the exchange rate effect is bigger than incorporated in the projections? we could also be wrong in the other direction : downside pressures on uk output growth ( chart 13 ) could yet lead to an even bigger fall in inflation than the central case. and, of course, there could be further shocks in either direction. so it is important to use whatever cross - checks on our projections that we can. one way to do that is to look for any nominal indicators that might signal risks of persistently above target inflation in the medium term, such as money or wage growth. underlying money growth is currently just over 1 % on an annual basis. and underlying wage growth is around 2 %. there are some tentative signs that money and wage growth are rising, but neither of these figures are even close to being consistent with above - target inflation in the medium term. taking these indicators together with the degree of slack in the economy – and given some of the factors likely to restrain growth in the uk and in europe – the economics of the situation does suggest that inflation should fall back from its current high point. but there are risks on both sides. on the one hand we need to be sensitive to the risk of tightening policy prematurely, stifling the nascent recovery. in that case, some of the flexible response to the recession could be swept away, delivering higher unemployment, more company failures and the risk of inflation significantly undershooting the target. the risk of deflation – which prompted the start of the mpc ’ s asset purchases in 2009 – may have faded, but it hasn ’ t gone away and would require greater efforts to deal with, if it materialised now. on the other hand, should it appear likely that inflationary

paul fisher : why is cpi inflation so high? remarks by mr paul fisher, executive director, markets, and member of the monetary policy committee of the bank of england, based on a talk to merseyside young professionals, liverpool, 14 june 2010. * * * annual cpi inflation reached 3. 7 % in april ( chart 1 ). given the monetary policy committee ’ s remit to target cpi inflation of 2 %, you might well want to ask “ how has inflation got so high and what is the mpc going to do about it? ” 1 i intend to tackle those questions head on this morning and, in the process, illustrate some of the challenges the committee faces in setting monetary policy. first we should note that inflation has become more volatile in the past few years than it has been at any time since the early nineties ( chart 2 ). cpi inflation had previously risen as high as 5. 2 % pa in september 2008 before falling back to just over 1 % pa in the autumn of 2009 and then rising to its recent peak. but historical data suggest that it was the stability of price inflation between 1993 and 2007 that was unusual, not the recent volatility which has been quite mild compared with the pre - nineties experience. the rise in inflation since mid - 2009 was surprising given that it happened against the background of a deep recession which generated the biggest fall in output in the uk economy since at least the second world war ( chart 3 ). the fall in output from peak to trough was around 6 % ( chart 4 ). and output is some 10 % below where it would have been, had it continued to grow at its pre - recession trend ( about 2 ¾ % between 1998 – 2008 ). may cpi data were published after the date of this talk : inflation fell back to 3. 4 %. one might have expected a recession of this depth to exert considerable downwards pressure on inflation – such that the current cpi inflation rate could easily have been negative. the recovery in inflation seems to reflect two factors. first, given the scale of the fall in demand, the downwards pressure from the recession doesn ’ t appear to have been as strong as it might have been. second, there have been a number of temporary factors pushing upwards. taking the impact of the recession first, the uk economy appears to have behaved differently during this downturn than in previous recessions. the number of company bankruptcies has been fewer than in the early nineties ( chart 5 )