LONDON (Reuters) - Inflation shot up to a 16-year high in August, making it harder for the Bank of England to cut interest rates to ease the economic pain of what many are describing as the worst financial market crisis in a generation.
Global stock markets tumbled for the second day running on Tuesday, spooked by this week’s collapse of investment bank Lehman Brothers and insurer AIG’s ongoing battle to survive.
Shares in HBOS, the biggest mortgage lender, fell more than 25 percent as interbank lending once again all but halted more than a year after the global credit crunch first entered the popular lexicon.
The Bank threw an extra 20 billion pounds into the financial system to ease the strains, but the cost of borrowing sterling funds for just a day jumped more than a percentage point to its highest level since April 2001.
In a letter to the government explaining why prices were rising so fast — the Bank’s inflation target is 2 percent — Governor Mervyn King said policymakers would keep the market turmoil in mind at their next rate-setting meeting.
But economists said there was little to suggest that the Bank was about to cut interest rates imminently after soaring utility bills pushed inflation to 4.7 percent in August, its highest since 1992.
King said he expected inflation to go higher still and stay above the target well into 2009, especially if the weakness of sterling persisted.
“Because the peak in CPI inflation is expected to be higher than three months ago, the risk that it may have an effect on other prices and other costs is now greater,” King wrote to Chancellor Alistair Darling.
“For that reason, the (monetary policy) Committee has become firmer in its belief that a period of muted economic growth is necessary to dampen pressures on wages and prices and return inflation to target.”
The economy already failed to grow in the three months to June for the first time since the slump of the early 1990s, and most economists expect output to fall outright in the second half of the year.
House prices have fallen by more than 10 percent in the last year, consumer confidence has crumbled and thousands of people are expected to lose their jobs in the construction, retail and banking sectors.
Around 5,000 people worked in Lehman Brothers’ London office alone.
“Prior to this weekend, we had reached a situation where the UK was expected by most to see a mild contraction in GDP over late 2008, followed by an anaemic recovery in 2009,” said Malcolm Barr, economist at JP Morgan.
“The events of the weekend and yesterday intensify concerns over the ongoing tightening in financial conditions.”
Finance minister Darling did his best to try reassure voters and financial markets before the stock market opened on Tuesday.
“This is clearly a very difficult time,” he told BBC radio. “I am confident we will get through this.”
But voters are angry and the Labour Party is trailing by around 20 points in the polls to the opposition Conservatives, putting them on course for defeat at the next general election expected in 2009.
Some Labour lawmakers are questioning whether Prime Minister Gordon Brown should remain leader and the party blocked a revolt on Tuesday, rejecting calls for a leadership election that could have threatened Brown’s 15-month-old premiership.
additional reporting by Christina Fincher and Matt Falloon