Rate-cut possible as Bank revises inflation forecast

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The Independent Online

Hopes that the next move in interest rates will be a cut rose yesterday after the Bank of England revised down its two-year inflation forecast.

Hopes that the next move in interest rates will be a cut rose yesterday after the Bank of England revised down its two-year inflation forecast.

Its quarterly outlook showed inflation staying below the 2.5 per cent target next year before hitting it in 2002. In August it said inflation would hit 2.7 per cent in two years. The inflation forecast would have been even lower, had the Bank not changed the level of sterling it used in order to avoid what it said would have been a "misleading picture".

The Bank insisted it would be unwise to call the peak in the rate cycle, saying the risks were "evenly balanced". Mervyn King, a deputy governor, said inflation would be volatile over the coming months as the oil price fed into the economy, making forecasting harder.

"The data ... might bear some resemblance to old-fashioned disco-dancing - sharp movements in unpredictable directions creating much excitement, accompanied by a good deal of noise," Mr King said.

The Bank said it was vital private sector demand continued to slow. Yesterday official figures showed retail sales unchanged last month, defying forecasts of a fall because of the floods, and boosting hopes that retailers may have a better Christmas than some had feared.

At the heart of its new forecast is an increasing optimism the UK can copy the American miracle of low unemployment, low inflation and strong growth.

The quarterly Inflation Report said: "The profile for inflation is softer than in the August projection." The main downward pressures were a weaker outlook for earnings, based on a new assumption that unemployment could fall further without triggering inflation, and the strength of sterling. "It was agreed that a small further adjustment should be made to the relationship between real earnings growth and unemployment, implying that wage pressures would be lower than for any given unemployment path."

But Mr King said the Monetary Policy Committee, which sets rates, still had a "completely open mind". Although productivity was picking up, there was little evidence of massive improvements that were central to the US economy. "The key question is whether the benign impact of the labour market is temporary and will pick up or whether it reflects something more permanent. The figures do look more benign than at the start of the year." The inflation measure used by the bank does not include mortgage costs.

Nick Stamenkovic at Nomura International, said: "The question is not whether a rate cut will occur but when. A rate cut by spring is a distinct possibility." But Stephen Lewis, chief economist at Monument Derivatives, said the MPC was still clearly split. "Agreeing to disagree, they keep rates on hold at 6 per cent. But next year we will see productivity is not playing that large a part and eventually the MPC will put rates up."

The Bank sparked controversy after it emerged it had changed a key assumption between August and November.

It normally uses an average sterling exchange rate over 15 days up to the forecast meeting. But it found that because a sudden and short surge in the pound, the forecast would show inflation constantly below 2.4 per cent. Instead, it used an average of the preceding five days. Mr King said: "The assumption would have given a misleading view of the outlook for inflation ... because the exchange rate was temporarily high."

Jonathan Loynes of Capital Economics said: "This may be perfectly innocent, but it looks suspiciously like a move by the more hawkish members to prevent the debate from moving too strongly [towards] rate cuts."

The European Central Bank kept its interest rates on hold at 4.75 per cent yesterday. It also said it would begin publishing economic forecasts, starting in December's monthly bulletin.