Mervyn King, Governor of the Bank of England, has been busy stirring up a hornets’ nest. Actually, maybe it would be more accurate to say several hornets’ nests. He has slammed banks, left Nick Clegg with a lot of explaining to do, and sounded a bleak warning over the economy.

This is what he said about banks: “I meet many people who run small and medium-sized enterprises and the thing that really makes them angry is that, having built up a business often over several generations and had the same banking relationship for 60, 80 years, then suddenly comes a letter churned out of a computer saying the terms of our relationship have changed; and I have seen many of these.” He added: 2It is heart-breaking sometimes. It is a lot harder to build a business than it is to sit in London and trade away.”

Dr King was venting his frustration over banks’ treatment of customers. Mind you, that’s the problem with bailing banks out. It kills evolution in the banking sector. But at least new banks seem to be emerging anyway. Maybe they will offer the service that the current crop of banks seem unwilling to offer. See: The great banking experiment: what matters most – price or service?

The second hornets’ nest relates to the UK’s Deputy Prime Minister. In the build up to the election, Nick Clegg was critical of Conservative plans to slash the fiscal deficit. And yet once the allure of power was waved in front of his eyes, all those doubts seemed to evaporate.

So why did Nick change his mind? Well, our Nick reckons he bumped into Dr King while treading the road to Damascus. The Lib Dem says the Bank of E man made it absolutely clear the government had to do more. But yesterday the central banker told a House of Commons select committee he said no such thing: “I said nothing that was not already in the public domain. In the telephone conversation I basically repeated what I had said at the press conference,” said the good doctor.

Actually, none of the politicians were honest with us before the election. Deep down inside they must surely have known cuts would have to be deeper than they were saying. But had they told the truth, they would not have been elected. Alas, the British public don’t vote for politicians who tell the truth, who say “I Don’t know””when in reality no one really knows, and they don’t vote for politicians who tell us things are going to be bad.

The final hornet’s nest that Dr King ruffled yesterday related to the economy. He said that because of the hike in VAT, inflation would stay above target for around 18 months. His colleague on the MPC, Charlie Bean, went further, saying: “Inflation has surprised us on the upside fairly consistently in the recent past. Some of that is because there have been unexpected events like oil prices that are substantially higher now than they were two years ago, but there are other aspects where basically our initial judgement about the inflation process turned out to be incorrect. In particular, it looks as if the effect of the depreciation of sterling has been rather larger and faster than we were expecting.”

But for all his doubts about inflation, Mervyn King hinted that rates would stay low for the foreseeable future. And he is right. The truth is, there are two types of inflation. There is the inflation that can get out of hand, caused by demand being greater than supply; this is what we had in the 1970s, and it got worse and worse. Then there is inflation caused by external factors. The VAT rise, the hike in oil and the fall in sterling are what lie behind inflation. In all three cases they have the effect of reducing demand. You will recall under Mrs Thatcher, a VAT hike was seen as an anti inflationary policy – at least in the long run. High oil, higher VAT and a cheap pound have the effect of reducing demand for UK consumers. As such, these forces are deflationary in the long run.

But where things can go wrong is when wages rise to match the increase in one-off costs. This is where we risk seeing an upward inflation spiral.

In other words, the good news is that inflation is unlikely because the recent price hikes have not been met with hikes in wages. The bad news is that the recent price hikes have not been met with hikes in wages.