Bank 'might need to miss target'

Bank of England governor Sir Mervyn King has admitted there are circumstances in which it would be justified to aim off the Government's inflation target to lower the risk of a financial crisis.

In his Stamp Memorial Lecture at the London School of Economics, Sir Mervyn said while the benefits of targeting price stability should not be forgotten, in the short run inflation targeting could increase the risk of financial instability.

The Governor and fellow members of the Monetary Policy Committee (MPC) have repeatedly defended their record despite missing the 2% inflation target for more than two years.

The consumer price index (CPI) rate of inflation fell below one percentage point from the target in May when it hit 2.8% and was last recorded in August at 2.5%.

The Governor argued that it would have been better to alleviate the risk of a crisis before 2007 with policies that tackle the stability of the whole financial system rather than altering interest rates, which are used to assist inflation targeting.

Sir Meryvn said a cap on the amount banks could borrow - or leverage - should have been introduced.

He said: "With hindsight, before 2007 there should have been a cap on the leverage of banks.

"And the cap should have tightened as asset prices increased and the likely exposure to losses increased. That is why we now have a macro-prudential policy regime in the UK."

But he added that so called "macro-prudential tools" deal with symptoms rather than the underlying problems such as household misperceptions of inflation.

Sir Mervyn said: "It would be sensible to recognise that there may be circumstances in which it is justified to aim off the inflation target for a while in order to moderate the risk of financial crises."