Inflation Report points way for interest rate cuts

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The Independent Online

The Bank of England's new inflation forecast, published on Thursday, will be revised from August's prediction, according to a City analysis of the Bank's economic model.

The Bank of England's new inflation forecast, published on Thursday, will be revised from August's prediction, according to a City analysis of the Bank's economic model.

The Inflation Report will provide the aggressive "doves" on the Monetary Policy Committee with fresh ammunition in favour of a reduction in interest rates, it says.

However, it also warns interest rate cuts would be premature because the tight jobs market would force wages higher in the months ahead. Separately, Incomes Data Services, the independent pay analysts, reports that pay settlements are continuing to edge higher.

A quarter of all recent deals are for pay increases of 4 per cent or higher, IDS concludes, and half are above 3.5 per cent. It has been monitoring a modest upward trend in settlements in recent months. "The higher inflation rate is having a knock-on effect on longer term deals."

The latest official earnings figures are due on Wednesday. They have shown an unexpected slowdown in earnings growth during the summer months, to 4.1 per cent in August from 5-6 per cent in the spring.

The report from Lehman Brothers, using a full replica of the Bank's own forecasting model, says the combination of a stronger pound and weaker-than-expected growth in average earnings during the past quarter will have shaved 0.3 percentage points off the Bank's inflation forecast. The difference is enough to ensure the inflation rate is on or below target in two years' time, rather than just above it as the August Inflation report predicted.

"It suggests that last week's MPC meeting might well have been touch-and-go between a rate freeze and a rate cut. The doves could well have voted for lower rates," said Michael Hume, of Lehman Brothers.

The model combines the impact of all the latest economic developments. While the oil price has been higher than the Bank forecast in August, its inflationary impact has been more than offset by a higher exchange rate and surprisingly slow growth in pay.

Mr Hume said the pre-Budget Report would not have had any impact on the inflation outlook but the tight jobs market and the likelihood of an expansionary Budget in March meant interest rates could still have to rise.

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