David Prosser: Gambling its credibility is the lesser of two evils for the Bank of England

Outlook One phrase leapt out of the Governor of the Bank of England's letter to the Chancellor yesterday. After explaining why inflation had yet again overshot the Bank's 2 per cent target by more than apercentage point (double the acceptable leeway in fact), Mr King said the Bank's current projection was for its objective to be met within "two to three years". That's a significantly longer time-frame than the Bank would normally use and further undermines the credibility of a Governor who has repeatedly had to revise his estimate of when inflation might fall back to within the target range.

The problem for Mr King is that the data he has often clung to in the past is now moving against him. It's not just that consumer price inflation stands at 4 per cent but also that core inflation, which excludes much of the commodity price uplift, has now hit 3 per cent. Even after the effect of indirect taxes – so excluding the sharp rise in VAT during January – inflation still stands at 2.4 per cent.

Does that mean the Bank's Monetary Policy Committee has made a mistake by not raising interest rates by now? Not necessarily. For one thing, that final figure of 2.4 per cent is not far off the 2 per cent target – if you were to strip out the effect of the depreciation of sterling, which Mr King listed yesterday as the third external factor in the CPI increase (after commodity prices and the VAT hike), the MPC might be right on the money.

More importantly, the MPC's job is not to deliver 2 per cent today, but over the medium-term. In seeking to do so it must be mindful of not prompting a fall in CPI to below 1 per cent, which would be just as bad a result, in terms of its mandated target, as the current overshoot. For many people it would be worse in fact, since it would mean the UK had returned to recession, with all of the implications for unemployment misery that would bring (not to mention the catastrophic effect on the Chancellor's fiscal projections).

In the context of the UK's fourth-quarter GDP figures, the risk of an interest rate rise prompting adouble-dip remains a real one. Now, those figures may be revised upwards and we may bounce back during the first quarter of this year – business confidence surveys are improving, even if the data does not yet reflect that – but until the Bank is presented with realevidence the recovery has been secured, downside risks for inflation are likely to go on outweighing the dangers on the upside.