Leading article: The Bank of England should hold its nerve

Yesterday's inflation figures were just the sort of start to 2011 that Mervyn King did not need. The Governor of the Bank of England has made it clear that he regards the present overshooting of UK inflation as a temporary phenomenon; a result of government VAT rises, a depreciated pound and soaring commodity costs. And, so far, the interest-rate setting Monetary Policy Committee of the Bank has agreed with the Governor.

But the inflation hawks have been circling in recent months, accusing the Governor and the Bank of being too blasé about rising prices. And yesterday's figures from the Office for National Statistics – showing that the consumer prices index jumped from 3.3 per cent to 3.7 per cent in December – are likely to prompt the hawks to go in for the kill.

Once again, inflation has outstripped the Bank's forecasts. Even core inflation (which removes volatile items such as energy and food prices) rose from 2.7 to 2.9 per cent. Inflation has been more than one percentage point above the Bank's mandated 2 per cent target for more than 13 months now. And it is likely to go higher still in the immediate term as the Coalition's VAT increase this month makes its full impact.

The Governor is faced with the prospect of writing yet more letters to the Chancellor explaining why the Bank has missed its target. The temptation for Mr King and the Monetary Policy Committee to succumb to the strictures of the hawks and raise rates (in order to demonstrate that they are taking inflation seriously) is going to be difficult to resist over the coming weeks.

Yet the MPC should hold its collective nerve. The hawks are right to point out that inflation squeezes living standards. These figures are indeed wretched news for savers and pensioners who live off their savings income. But the fact remains that there is no sign of inflation becoming domestically embedded.

Wages are still stagnant. Despite rising prices, workers are not pushing for salary increases. Most are simply content to retain their job in an economic environment of still high unemployment. Public sector workers already know they are facing a real terms pay freeze.

Other indicators are stable. The domestic money supply is still growing only weakly. The ONS says the biggest drivers of this burst of inflation were air transport, fuel, utility bills and food costs, confirming that these latest price rises are a result of external, not home-grown, factors.

All this suggests the Governor's central analysis that inflation will fall back in time remains a reasonable position. The economy is still below full capacity. Until that is reached, there will be downward pressure on prices. The Coalition's spending cuts of 1.5 per cent of GDP per year over this Parliament will also have a dampening effect.

Raising interest rates now would stifle economic activity, by increasing the cost of borrowings to all businesses. It could also create a new crisis in our banking sector because it would result in a slide in the value of their holdings of UK sovereign bonds. Those are the last things our economy needs as it undergoes an extreme fiscal squeeze.

Rising inflation does mean economic pain. But raising interest rates now would not be a pain-free option. Most borrowers would see their mortgage costs rise instantly. And a surge in unemployment, a house price collapse and general economic dislocation could follow. There will come a time when rates need to rise. But the economy has not reached that point yet. The Monetary Policy Committee needs to back its convictions with courage.