Bank of England Governor Mervyn King has issued his clearest warning yet that recent jumps in the money supply could be a signal that rates are not high enough to bring inflation back under control.

His warning, which formed part of a lengthy lecture delivered last night to the Society of Business Economists, will be taken as a sign that the Bank's Monetary Policy Committee is prepared to lift interest rates to 5.5pc next week, and very possibly again thereafter.

In some circles it may even be regarded as a hint that the committee's remit should be changed to allow it explicitly to target money growth, rather than solely inflation.

The speech came only hours after fresh figures from the Bank showed an increase in the growth of money levels in the UK economy.

In his first public appearance since having to write a letter of explanation to the Chancellor following the rise in the Consumer Price Index to 3.1pc, Mr King said policymakers would be foolish to ignore data on money supply.
He said: "Why does money not play a more prominent role in discussions of the outlook for inflation and monetary policy?

"It is quite possible, in the real world, for there to be unwarranted money supply shocks - whether stimulus or restraint.

"The Monetary Policy Committee must always be looking for warning signals of this. The trap is falsely to conclude that, because some economic models contain no explicit reference to it, money cannot be one of those signals."
He added: "The growth of money and credit may signal in advance of other indicators that Bank Rate is set at a level inconsistent with bringing inflation back to the target in the medium term."

The recent jump in money growth to 16-year highs has reignited the debate over whether policymakers should be targeting the money supply as well as inflation.

However, while there are undisputed links between high inflation and high money growth, there are often other more complex reasons for increases in money, which do not signal higher inflation.

Mr King said that the Bank was now preparing a series of studies to analyse the situation.

The Bank said that annual money supply growth rose from 12.7pc to 12.8pc, not far from the peaks it scaled late last year.

Mr King also admitted that there was still room for the Bank to improve its communications with the market, after two recent interest rate decisions caused major jitters.

However, the Governor dismissed proposals for the Bank to publish explicit interest rate forecasts.

Finally, in what may be seen as a defence of the institution as it comes under the most intense fire since being granted independence a decade ago, Mr King said the Bank could claim responsibility for much of the stability and economic growth in recent years.

He said: "The crucial achievement of the Monetary Policy Committee is to have anchored inflation expectations.
"But, as the saying goes, we are only as good as our last meeting. We fully recognise that we must keep our eye on the ball if we are to continue to anchor inflation expectations on the 2pc target."

Source: The Telegraph