The Bank of England's nightmare scenario is that households and companies begin to think higher inflation is normal.
So worried is the monetary policy committee that it mentions "inflation expectations" 53 times in the 52-page document - twice the frequency of its previous inflation report.
If people and companies expect consumer price inflation to be well above 2 per cent, employees will demand higher pay increases, companies will be more willing to pay and households will not complain too much about companies raising prices. That is what happened through the 1970s and in much of the 1980s.
The remedy is painful. "Reducing inflation expectations from persistently high levels has in the past required prolonged periods of tighter policy and lower growth," the report warns.
But although the Bank did not say it explicitly, there are compelling reasons for households to believe normal inflation rates have risen.
First, the recent history of inflation and the Bank's inflation forecasts show CPI inflation above 2 per cent for almost the entire period between 2005 and 2010.
Second, Mervyn King said it was "more likely than not" he would have to write a second letter of explanation to the chancellor if CPI inflation exceeded 3 per cent later this year. The public may well be tempted to borrow from Oscar Wilde's The Importance of Being Earnest and decide that the first letter was a misfortune, while the second looks like carelessness.
Third, with inflation measured by the retail prices index at 4.1 per cent, the RPI excluding mortgage interest payments running at 3.4 per cent and everyday items that are purchases rising even faster in price, households believe normal inflation is much higher than 2 per cent. When people are asked what they expect inflation to be, they now give answers much higher than the Bank's 2 per cent target. The latest Citigroup/YouGov poll stood at 3.3 per cent.
The comparison between yields on regular and index-linked bonds also shows a rise in the markets' expectations of inflation to well over 3 per cent at the five-year horizon. The Bank is sanguine about this evidence. But it knows inflation expectations are a serious risk.
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