Rate fears as Bank warns on inflation outlook

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The Independent Online

Interest rates are likely to have to rise further, the Bank of England's quarterly Inflation Report indicated yesterday. It forecast inflation would breach the 2.5 per cent target if rates remain at their current level of 6 per cent.

Interest rates are likely to have to rise further, the Bank of England's quarterly Inflation Report indicated yesterday. It forecast inflation would breach the 2.5 per cent target if rates remain at their current level of 6 per cent.

The Bank insisted there was no "mechanical" link between its monthly interest rate decisions and its long-term forecast, which shows inflation hitting 2.7 per cent in two years' time. City economists expressed surprise yesterday that the Bank had been prepared to publish, for the first time in more than two years, a forecast showing inflation likely to be above target without having raised interest rates pre-emptively.

But Mervyn King, the Bank's deputy governor, said: "The immediate outlook is not one of cutting interest rates." He warned that if an increase in loan rates is to be avoided then pay rises must not accelerate despite the tight jobs market, and growth in consumer demand must slow further.

The report showed the Bank expects inflation to rise faster than it forecast three months ago. The 4 per cent fall in the value of the pound since May's Inflation Report had pushed the projection higher, it said. This was partly offset by signs that consumer spending and earnings growth were slowing.

The report reflected clear divisions between the nine members of the MPC, particularly over the prospects for an improvement in productivity growth in the UK. Some members of the committee believe the UK could in future enjoy a version of the US "New Economy", allowing faster growth with low inflation. But Mr King said there was no evidence of an improved productivity performance in Britain, which had been weaker than expected in recent years.

Other key differences between MPC members included the pressures for price cuts on the high street and the outlook for sterling. According to the report the uncertainties could raise or lower the inflation forecast by up to 0.5 per cent. "The risks to the inflation outlook lie on both sides," Mr King said.

He said the revision to the forecast did not mean the MPC had been wrong to keep rates unchanged at 6 per cent when it met last week. "I would urge you not to focus on differences of a fraction of a percentage point," he said.

The Bank also attempted to defuse the politically charged issue of the impact of £43bn rise in the Government's spending plans on the inflation outlook. "The committee has taken the view that these uncertainties do not affect overall inflation prospects," Mr King said.

The financial markets were largely unmoved by the report, which contained ammunition for both sides of the monetary policy debate despite its slightly "hawkish" forecast.

Robert Barrie, of Credit Suisse First Boston, believes rates have peaked. He said: "I did not hear anything that would change my view. The MPC still has a tightening bias but I would be hopeful it will not materialise in a rate rise."

Other economists focused on the Bank's upward revision to the inflation forecast. "The fact the Bank is acknowledging that inflation is going to breach the target raises the question why they did not raise rates last week," said Nick Stamenkovic, senior analyst at IDEAglobal.com. Richard Iley, of ABN Amro, said: "By projecting inflation above target in two years' time ... the MPC missed a golden opportunity to cement its reputation for pre-emptive monetary policy."

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