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Bank boss cool over new inflation rates.

Byline: John Cranage

The change to the way in which UK inflation is calculated should not affect companies' pricing and wages decisions, Mervyn King, Governor of the Bank of England, told a business audience in Birmingham.

Nor will it make any difference to the way the Bank's Monetary Policy Committee sets base rate.

In the first of only four major policy speeches he is due to deliver this year, Mr King said the gap between the two gauges would narrow as house prices cool down. Under the old retail prices index (RPIX) the MPC was set an inflation target of 2.5 per cent by the Government.

But since December the target under the new consumer prices index (CPI), which ignores house prices and council taxes, has been two per cent.

Under RPIX, inflation was at or above target for the whole of 2003. In contrast, the CPI measure was below two per cent for all bar three months since May 1997.

In a detailed and technical analysis of the difference between the two measures, Mr King said CPI reduced the weight given to retail outlets where prices were rising fastest and allowed the overall measure of inflation to take into account the way families switch their shopping to cheaper outlets.

'For that reason the formula used to calculate CPI inflation is superior to the formula used in RPIX.

'Arcane though it may sound the 'formula' effect reduces estimated inflation in Britain by about half a percentage point a year.'

Mr King went on to tell a 300-strong audience at the annual Birmingham Forward/CBI business lunch at Villa Park that two formulas were similar to centigrade and fahrenheit as measures of heat.

'In both cases moving from one measure to another changes the number without there having been any change in the temperature itself.'

Because the underlying economic data is the same, 'the switch to a new CPI target has in itself no implications for the monetary policy', Mr King said.

He added: 'But just as changing from fahrenheit to centigrade has not proved easy for those who had become used to the old measure so it will take time for us all to adjust to the new inflation measure.'

Because house prices and council tax were not included in the basket of goods and services used to measure CPI inflation, the difference between CPI and RPIX had become exaggerated.

He went on: 'At present the difference is unusually large. It peaked at 1.7 percentage points in June, since when it has narrowed to 1.3 percentage points but remains well above the 0.5 per cent change in the inflation target.

'Does this mean that monetary policy in the coming months will need to be looser under the new target than it was with the old target?

'The answer is no. The large difference between the two measures of inflation at present can mostly be explained by house price inflation. It is unlikely that house prices will continue to rise at their recent pace for much longer.'

The MPC takes a 'reasonable central view' that house price inflation is likely to subside over the next two years and the gap between RPIX and CPI will narrow to about half a percentage point. Mr King stressed though that the MPC would continue to closely monitor house price and wages trends in case they signal an impact on future inflation trends.

CAPTION(S):

Mervyn King of The Bank of England at The Holte suite, Villa Park, Birmingham Picture, SIMON HADLEY
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Publication:The Birmingham Post (England)
Date:Jan 21, 2004
Words:591
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