King's focus on inflation dampens hopes of a series of rate cuts

Bank's forecast points to rising prices; Unemployment falls; Sterling gains

The Bank of England dampened hopes of a series of interest rate cuts as the Governor hammered home his determination to keep to the 2 per cent inflation target over the medium term.

The central bank's quarterly Inflation Report yesterday predicted inflation clearly above target in two years if rates fall in line with market expectations to 4.5 per cent this year. But hopes of at least one more cut were sustained by figures showing inflation below 2 per cent if they remain unchanged.

The Governor, Mervyn King, stressed the balancing act that the Monetary Policy Committee has to perform in what he predicted would be the hardest year since the Bank gained independence in 1997. The MPC faces a sharply slowing economy combined with rising inflationary pressures.

He said he was prepared to let inflation overshoot target this year, triggering an explanatory letter to the Chancellor, to ensure the required average over two years. Short-term increases in food, energy and import prices would give a temporary boost to inflation as long as people did not start to believe they were permanent, Mr King said.

The MPC cut rates last week by a quarter of a percentage point to 5.25 per cent in a widely expected move. Markets had been betting the committee would make three more reductions in 2008 to stop the economy from sliding into recession.

The Governor's comments came on a day of encouraging economic news. Unemployment fell for a 16th straight month to a three-decade low in January as companies hired employees, Office for National Statistics figures showed. Average earnings rose an annual 3.8 per cent in the three months to the end of December, down from 4 per cent in November.

Lai Wah Co, principal economist at the Confederation of British Industry, said: "The Bank's task is to look through short-term volatility and deliver its 2 per cent target over the medium term. Inflation is still expected to fall back later in the year, helped by a slowing economy. This is why the Bank is signalling that it might be able to cut rates once, or possibly twice, over the course of the year."

Mr King talked down fears of a sharp slowdown in the econ-omy and added that many regions of Britain were still thriving. "Once you get away from London, and certainly the City, and away from the financial sector... the mood music is very different," he said. While most retailers will feel this is their worst year for a decade, exporters will benefit from the recent decline in the value of the pound, he added.

Verdict Consulting warned that retailers would be hit by contracting like-for-like sales that would force some to go to the wall.

Sterling rose against the dollar as investors pared bets on the number of rate cuts this year. But many economists expect a further reduction in May, with at least one more by the end of the year.