U.K. Says Higher Rates Would Take Heavy Toll

New data showed the UK's annual inflation rate leaped to 3.3% in May, and Bank of England Gov. Mervyn King set a 2-year timeframe to nudge the rate to the central bank's 2% target. King, in a letter to the government, warned against raising interest rates because it would take a heavy toll on growth and employment. He said the bank would adhere to the longer-term view unless workers begin getting pay raises to offset the impact of rising oil and food prices. Data showed the annual rate of inflation rose to 3.3% in May, its highest level since 1992, from 3% in April. Mr. King said the rate is expected to move above 4% in the 2nd half of 2008 and remain "markedly above" the 2% target well into '09. When the inflation rate is above 3%, the central bank governor is required to write a letter to the government explaining why prices are rising and what the bank intends to do about it. Holding the line on wages and public spending poses new challenges for Prime Minister Gordon Brown. A slowing economy, rising inflation and an accelerating slide in house prices have saddled him with a 25% approval rating, the lowest for a prime minister since World War II. Arguing for workers to accept shrinking disposable incomes won't help his standing. The government is locked in wage disputes with public-sector unions, some of whom have threatened to cut funding for Mr. Brown's Labour Party. Mr. King said rising energy and food prices are largely responsible for the increase in inflation, which interest rates can't control. He said if the Bank rate were set to bring inflation back to the target within the next 12 months, the result would be unnecessary volatility in output and employment. Mr. King said the period in which the inflation rate is likely to remain above target will be "temporary, provided wage increases remain modest and don't feed future inflation." King's remarks cast doubt over recent market speculation the central bank would move to raise interest rates soon. A U.K. economist at UBS said the key message was that inflation will be stable and low in the medium term, provided wage settlements remain subdued.