Rapid growth in the supply of money and credit in the economy may be a warning signal of inflationary risks, Mervyn King, the Bank of England Governor, conceded last night, in comments that will harden expectations of new interest-rate increases.

After an attack on the Bank last month from economists who accused its Monetary Policy Committee (MPC) of paying too little heed to the role of money growth in the recent surge in inflation, Mr King admitted that these factors could signal that base rates had been at the wrong level.

“It is quite possible for there to be unwarranted money supply shocks . . . The MPC must always be looking for warning signals of this,” he said. “There are times where monetary developments have . . . [proved] a warning sign of inflationary risks.”

The Governor’s comments, to the Society of Business Economists, came as he defended the MPC’s record amid a recent outbreak of criticism since inflation climbed to a ten-year high of 3.1 per cent, forcing him for the first time to write an explanatory letter to the Chancellor.

However, in a separate interview, Mr King admitted that the Bank was “clearly” failing to communicate effectively to financial markets how it was likely to react to economic data.

A Reuters poll showed that half of City economists believe that the Bank’s communications have become less effective over the past year. With nine MPC members voting, Mr King told the society, it was inevitable that there was “often some suspense as to the final outcome” each month. But he said there was “little evidence that markets have been particularly uncertain” about UK rates.

Mr King dismissed suggestions that the stability and strength of the UK economy since the MPC took the interest-rate reins in 1997 was down to luck and insisted that Bank independence had been a “sea change” that amounted to a “revolution in the way decisions on interest rates are made”.

He said that the economy’s behaviour was better both in terms of its performance and reduced volatility “and that improvement has been more marked in the UK than in the rest of the G7”.

Although structural reforms may have helped to deliver this, he argued that “the new monetary framework has also played a key role”, ensuring that companies’ and households’ future expectations of inflation were anchored. “As a result, inflation and output growth have been remarkably stable,” he said.

In the wake of the attack on the MPC from monetary economists, including Charles Goodhart, a founding member of the committee, Mr King sought to assuage claims that the Bank had paid too little attention to money supply.

There were important practical problems in gauging implications of these trends, depending on whether they were driven by demand for money or by its supply, he said, but he revealed that the Bank was “trying to develop models to help us to distinguish between demand and supply shocks to money, and we shall be devoting more resources to this task”. He said that “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”.

After a claim this week from the National Institute of Economic and Social Research that March’s rise in inflation to 3.1 per cent was due to the Bank pushing base rates too low, Mr King also emphasised that since the mid-1990s “inflation in the UK has been lower than for a generation”.

“Inflation has been significantly lower on average, less variable, and fluctuations . . . have tended to be less persistent,” he said.

He said that was despite the Bank having to contend with big economic upheavals, including the Asian financial crisis and Russian default of 1998, and the world IT-led slowdown at the turn of the decade.

Fears of a series of further increases in base rates were eased, meanwhile, as the Bank’s latest data showed mortgage approvals slowed in March to their weakest level in almost a year.

Explore Economics

• Pre-Budget Report 2008

• Budget 2009

• World Economic Forum

• The Times MPC

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive