Bank points way to still higher rates

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The Bank of England yesterday raised its growth forecasts and warned of inflationary pressures, sending a clear signal that interest rates must rise again.

Its quarterly Inflation Report showed economic growth running well above trend for the next two years and inflation heading above its new 2 per cent target. But it hinted that any further rises would be gradual, saying the rise in the pound would help contain inflation. "Our recent months' growth in the UK has been strong [and] is expected to remain so," Mervyn King, the Bank's Governor, said.

He said that although inflation was below target now, the Bank forecasts it rising above the target over its two-year horizon, justifying last week's increase in the base rate. "There are already some signs of higher inflation to come," he said. "The growth of money and credit remain at very high levels and there is evidence of greater cost pressures in the pipeline."

He said the headline inflation figure ­ currently languishing at 1.3 per cent ­ was "concealing some pick up in inflationary pressures", adding that goods prices were no longer falling. The Bank refused to put figures on growth but the report showed GDP growing by between 3 and 3.5 per cent this year and next; in line with Treasury forecasts.

The Bank has also abandoned its warning of "downside" risks to growth, instead saying the risks to forecasts for inflation and GDP were balanced. The Governor added that the 2 per cent rise in sterling's exchange rate would offset part of the inflationary pressure.

He said the Bank had also lowered its estimate of the level of unemployment that sparks inflationary pressure. This view was supported by official figures yesterday showing that earnings growth had slowed despite a drop in the jobless rate.

The ILO measure of unemployment fell 21,000 on the three months to December to 1.46 million, the lowest since May 2001. The jobless rate edged lower to 4.9 per cent, the joint lowest since 1984. But at the same time growth in average earnings slowed to 3.4 per cent in the final quarter from 3.5 per cent in the previous three months.