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Spencer Dale warns of 'aggressive' rise in rates if Bank of England loses credibility on inflation

Interest rates will have to rise "aggressively" if the Bank of

England loses its credibility on controlling inflation, its chief economist

Spencer Dale has warned.

By Philip Aldrick

Published: 6:00AM BST 23 Sep 2010

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'The Bank of England loses credibility at our peril', warned Spencer Dale Photo: Daniel Jones

In a speech on Wednesday night to the Cardiff Business School, Mr Dale sought to silence the "dangerous voices" questioning the Bank. He stressed that policy-makers have "not gone soft on inflation" in a stark rebuttal of City suggestions that they are turning a blind eye to their central remit.

"We lose our credibility at our peril – once the genie of inflation credibility escapes it is costly to put back," he said. "The response to a possible loss of credibility is clear – monetary policy would need to tighten, possibly aggressively so."

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However, he acknowledged that there was substance to the concerns. Inflation has been "significantly higher than the 2pc target" for the past four years, he accepted. "The period of above target inflation; the fact that inflation has been higher than expected; and that it is likely to remain above target until the end of next year all contribute to the risk that credibility and confidence in the MPC may start to waver."

Explaining why inflation has been above target, he said: "It is not difficult to find factors ... The economy has been hit by a series of large price level shocks – to oil and other commodity prices, to VAT and to the sterling exchange rate."

Economists fear that inflation expectations may decouple from actual inflation levels, prompting wages and prices to start rising at elevated levels – turning inflation into a self-perpetuating problem.

Mr Dale added, though, that he is not currently concerned. "Although this remains a significant risk, my reading of the available evidence to date is that inflation expectations remain relatively well anchored," he said.

He added that there remain severe "downside risks to inflation ... stemming from the substantial fiscal consolidation now in train and the continuing constraints on the supply of bank lending".