Dear Darling... as I predicted, inflation has risen to 3.5%

Inflation hit 3.5% in January — more than 1% above the 2% target, so high enough to trigger the open letter of explanation from the Governor to Alistair Darling.

"Temporary" is King's verdict on the inflation spike. He forecast such a rise followed by a sharp fall at the Bank of England's quarterly inflation report just last week.

The volatile nature of inflation over recent months helps to explain why the Bank decided not to extend quantitative easing beyond the £200 billion it has already pumped into the economy through the purchase of assets such as gilts and bonds.

The decision not to print more money, taken early this month, fuelled fears that the monetary policy committee will raise interest rates sooner rather than later to bring inflation back under control.

King's letter today suggests no such move is imminent.

He blames three "short-run factors" for the rise in inflation last month — the rise in VAT from 15% to 17.5%, a 70% increase in oil prices, and the impact of the sharp fall in sterling in 2007 and 2008 which pushed up import prices. "The direct effect of the short-run factors on inflation should be only temporary," explains King.

"Thereafter, inflation will be determined by the growth rate of nominal spending relative to the supply capacity of the economy. Nominal spending fell significantly during much of the previous year, although it bounced back somewhat in the third quarter. That weakness in spending has created a substantial margin of spare capacity within the economy. The committee expects that will bear down on inflationary pressures over time."

The letter goes on: "The MPC's latest projections, published last week in the February inflation report, suggest that, although it is likely to remain high over the next few months, inflation is more likely than not to fall back to the target in the second half of this year, as the short-run factors wane and the influence of spare capacity builds. Thereafter the committee judged that inflation was more likely than not to move below the 2% target for a period."

The Chancellor seems happy enough with the Bank's assessment.

In his "Dear Mervyn" letter today, Darling says the Bank's forecasts are "similar" to those he set out in the pre-Budget report in December.

"The MPC's remit allows it to look through short-term movements in inflation," writes Darling. "Although inflation is temporarily above the target, the February inflation report suggests that the underlying pressures to inflation are to the downside." He goes on: "With the world economy emerging from the deepest downturn in modern times, inflation outlook remains subject to uncertainty. But prospects for the UK and the global economy are better than 12 months ago."

The reaction in the City to the inflation figures is relief. Some experts had feared that inflation would top 4% last month, throwing the Bank's forecasts way off target.

The Bank's central projection is for inflation to fall to around 1% later this year before edging back to 1.8% by the time of the London Olympics in 2012.

King made it clear at the inflation report — as he does today — that the Bank will not try to control the short-term inflation spike.

"Monetary policy can do little to affect these short-run movements in inflation," he said. Further clues as to what the Bank will do next will emerge tomorrow when the minutes of this month's MPC meeting are published and we see who voted for what.

It would be no surprise if some members — David Miles among them — wanted to print more money, suggesting a reversal of QE and rate hikes are some way off.

King tells the Chancellor today that the Bank is ready to pump yet more money into the economy should inflation fall further than expected, or raise interest rates should inflation threaten to remain above 2%.

In other words, King and co are more than happy to wait and see.

Barring any shocks — and Threadneedle Street does not have the best forecasting record — the Bank is set to leave rates at 0.5% and hold off withdrawing QE for some time to come.

A rate rise looks unlikely before August or November.