Will he or won't he?

Bank of England Governor Mervyn King, that is. Will he or won't he start raising interest rates soon? Yesterday, in the wake of news that CPI rose to 4% in January, King had to pen another of his now-customary letters to the Chancellor of the Exchequer, explaining why inflation is so far above the agreed 2% target. This was the key sentence:

"The MPC's-central judgement, under the assumption that Bank Rate increases in line with market expectations, remains that inflation will fall back so that it is about as likely to be above the target as below it two to three years ahead."

The market, together with most media commentators, saw this as a subtle shift in the Bank's outlook, one that made it likely that rates would start to rise as early as May. A much less considered reaction, however, came from dear old Anatole Kaletsky, writing in today's Times (behind the paywall; sorry!) Anatole thinks that King has "panicked", and that steps to raise interest rates make a double dip recession a near-certainty.

Now, one might quibble that with inflation moving steadily above target for the past year and unlikely, in the Bank's own judgment, to fall back to the target for another 2-3 years, that the term "panicking" might be just a slight exaggeration on Anatole's part. Actually, though, it's just Anatole up to his usual trick of getting every possible forecast into print at least once. As he points out, until yesterday he did not assume a double dip was likely. Now he thinks one is probable if the Bank raises rates as much as the market is currently pricing in (a terrifying 75 bp by the end of this year), and things could get really nasty if the market keeps boosting its expectations for future rate hikes and the Bank keeps following the market's lead. I'm quite sure that last part not what King's letter means, but hey, it's allowed Kaletsky to cover all the bases, so that's OK, right?

Perhaps it's all moot anyway. Today the Bank released its Quarterly Inflation Report, and it seems, to the market at least, to be a bit less hawkish on the inflation outlook. The bit about inflation returning to target in the medium term, on the assumption that rates rise in line with market expectations, is still there. However, the message that comes out of the Report loud and clear is one of a more than customary level of uncertainty on the part of the Bank's decision makers. They're uncertain about the growth outlook, and so they're not sure about how much spare capacity there will be in the economy, and that makes them unsure to what extent and how soon weakness in the economy will help to purge current "one-time" factors (high energy prices; high commodity prices; high import prices, the VAT increase) from the CPI.

Sadly, their lack of confidence is not unwarranted. It's not that long ago that the Bank was forecasting that CPI would be around 1% in early 2011, as opposed to the current 4%. Fair enough, the Bank couldn't be expected to have forecast the VAT increase, but even the CPI measure that excludes indirect taxes rose 2.4% in January and is showing signs of accelerating. (Stephanie Flanders has done a very good job of dissecting the data in her blog on the BBC website). The Bank observes that the underlying path of inflation is higher than was forecast in its November Inflation Report as a result of higher energy prices and rising import costs.

With monetary policy in the US, UK, Japan and elsewhere remaining loose, these can hardly be said to be unpredictable developments. However, one searches the Report in vain for any recognition that worldwide inflationary pressures are in any way attributable to past policy decisions. The fiscal actions of the coalition Government -- the spending cuts, the VAT hike -- have pushed the Bank into a tight corner, but it will be playing a dangerous game if it does not raise rates "in line with market expectations".