Inflation likely to overshoot target, Bank says

The chances that inflation will overshoot the Government's target have risen over the last months, the Bank of England said yesterday.

The warning, coupled with an unexpected fall in unemployment, compounded fears the next move in interest rates will be up. However the report, together with comments by Bank officials, appeared to show the Monetary Policy Committee was in no hurry to pull the trigger.

The Bank's quarterly report showed inflation, currently 2.6 per cent, would return to 2 per cent but rise back gently to the 2.5 per cent target by 2004. "The balance of risks to the inflation outlook relative to the central projection lies on the upside," the report said. It said the risk of inflation exceeding 2.5 per cent is now almost 60 per cent, compared with 50:50 in November, and 40 per cent in August.

Mervyn King, a deputy Bank governor, said the key upside risk was a sudden end to the current consumer boom that could trigger a fall in the pound, which would put up the price of imports.

The bank defended its decision to keep rates on hold last week while inflation was below target. "When the projection is close to the target, when it is rising at the two-year horizon and when the risks are on the upside, it is not very difficult to reconcile that outlook with keeping rates unchanged," Mr King said.

He steered analysts away from reading too much into Tuesday's inflation figures. They showed inflation surged from 1.9 to 2.6 per cent, the sharpest rise in more than a decade.

City analysts said the report might already be redundant as it had not taken account of the inflation surge. Michael Hume, UK economist at Lehman Brothers, said: "There is a distinct whiff of them being behind the curve and vulnerable to obsolescence in the event of more upbeat data."

New evidence of an upturn came from the labour market, where the number out of work and claiming benefit unexpectedly dropped last month.

Official figures showed the claimant count fell 10,600 to 951,300, compared with forecasts of a 6,000 rise. Meanwhile, the number in work rose 80,000 in the final three months of 2001 to hit an all-time record of 28.23 million. This was contradicted by separate figures showing a rise in 34,000 in the number of people unemployed according to international standards.

There were also conflicting signals from earnings data. The headline rate dropped from 4.1 per cent in November to 3.3 per cent in December, the sharpest fall since 1993. The main reason was a fall in City bonuses.