The Bank of England has signalled that interest rates will need to rise one more time to drag inflation back to its 2 per cent target. But in a welcome consolation to homeowners and business, it also hinted that rates could be coming down again next spring.
In its quarterly Inflation Report yesterday, the Bank predicted that inflation would fall from its current 2.7 per cent to about 1.8 per cent by the end of this year thanks to tumbling energy costs and lower import prices. It is then seen picking up again to hit the 2 per cent bull's-eye at the two-year horizon - the point at which current interest rate decisions have their biggest effect. Thereafter, it drops back down again.
Its forecast assumes that rates will be lifted by another quarter-point in the second quarter - a move that is already priced in by financial markets. Under the alternative assumption that rates are frozen at their current 5.25 per cent, the Bank believes that inflation would clearly overshoot the target.
"The Bank is keeping the door ajar for another hike but I'm doubtful it will have to go beyond 5.5 per cent," said Nick Stamenkovic, economist at Ria Capital Markets.
Jonathan Loynes, chief European Economist at Capital Economics, said: "We had previously assumed that rates would rise again in April but we now think a March hike is more likely. But the forecast shows inflation dropping back below its target beyond the two-year horizon. On the face of it at least, that suggests rates may need to fall a bit in a year's time."
Mervyn King, the Bank's Governor, stressed the forecasts were riddled with uncertainties, not least because of sharp changes in energy prices. He said inflation had been remarkably volatile by the standards of the past decade - rising from 2.4 per cent in October to 3 per cent December, and then falling to 2.7 per cent in January - and the medium-term outlook was what mattered.
"Just as 3 per cent inflation did not mean the end of the world was nigh, so 2.7 per cent does not mean that we can ignore concerns about inflation ahead," he said. "The outlook over the next year is highly uncertain because of the large impact which reductions in gas and electricity prices are likely to have on inflation."
Mr King said it was too soon to gauge the impact of wage increases, traditionally negotiated early in the year, adding that the annual pay round had less impact than it used to. "I think it's much too early to know what will come out of the wage round and I would caution against putting too much weight on it," he said.
Yesterday's official average earnings figures, showing a fall from 4.1 to 4 per cent in the three months to December, are likely to provide reassurance. But it may be concerned about the tightening labour market. Claimant count unemployment fell by 13,500 in January, its biggest one-month drop for nearly three years.
The Bank predicted strong economic growth, expecting it to peak above 3 per cent in the middle of this year before easing back to about 2.8 per cent as public and consumer spending slow.
Meanwhile, the latest monthly report from the Chartered Institution of Chartered Surveyors, published today, shows house price growth eased to its weakest for seven months in January as higher interest rates continued to bite. Some 28 per cent more surveyors reported a rise in house prices than a fall, down from December's 36.6 per cent and the lowest balance since last June.Reuse content