BoE forecast dashes hopes for rate cut

Inflation will fall below 2.5 per cent this year, the Bank of England predicted in its quarterly Inflation Report yesterday. But it warned that the risk of inflation climbing above the Government's target in 1998 made it difficult to see a case for cutting interest rates further.

Mervyn King, the Bank's chief economist, said the recent reductions in the cost of borrowing had been a reaction to the danger of a slowdown in the economy. ''You can see it as taking out an insurance policy against the downside risk. There is a case for continuing to pay the premium for a while longer but it is not easy to see the case for increasing the premium,'' he said.

The Inflation Report warned that it was at this stage of the cycle that policy mistakes tended to be made, with short-term weakness in manufacturing masking the future buoyancy of the economy. Although its forecast showed inflation at 2.5 per cent in two years' time, it was ''marginally more likely than not'' that it would climb above the target if base rates were left unchanged at their current 6 per cent level.

Economists interpreted the Report as a signal that the Bank would oppose another interest rate cut. ''The Bank is letting us know that the next move will be up,'' said James Barty, an economist at investment bank Deutsche Morgan Grenfell.

Some City analysts think a rise will be needed later this year. However, most think rates will not be changed until the general election. ''It is difficult to see the Bank prevailing on the Chancellor to raise rates before then,'' said Bill Martin, chief economist at UBS.

Mr King said that how soon monetary policy would need to react to evidence of risks to the inflation target in the future depends on how the economy evolves in the next few months.

According to the Report, two factors might slow growth in the short- term: weaker exports to Europe and the overhang of stocks. However, these dangers were diminishing.

Other indicators suggested that growth would pick up next year. The Bank predicts above-trend growth in consumer spending and expects investment to increase.

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