Rate rises loom as Bank acts to rein in inflationary pressures

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The Bank of England warned yesterday it was prepared to take action to quell inflationary pressures as its latest forecasts implied the need for a rise in interest rates in the coming months.

Inflation will overshoot the Bank's 2 per cent target for the whole of the next three years if interest rates stay at 4.5 per cent, its quarterly inflation report showed. Feeding in market assumptions that rates will be raised once or even twice shows inflation returning to target at the end of the forecast horizon.

The tone of the report was not as hawkish as some analysts had expected and the Bank said it was forecasting weaker growth than it did in February.

The markets, which pushed the pound up on expectations of a more hawkish report, pared their outlook for rate rises as traders concluded that while the next move in rates was still upwards, the first rise would not come as soon as many had expected.

Mervyn King, the Bank's Governor, refused to forecast the direction of rates but said analysts in the markets could "work out the implications for themselves".

He said there were many risks around the forecast for inflation, including the surge in oil prices above $75 (£40) a barrel and the latest increase in energy prices.

The Monetary Policy Committee would keep a close eye on inflation expectations, which had risen to record levels according to the Bank's own research, he said. "Inflation expectations are central to our framework and are a very important influence on the extent to which costs increase get passed on in higher prices and the level of wage settlements." He said the rise had been "small so far" but added: "If that rise in inflation expectations were to persist or go further, then I think the committee would be concerned."

It made a veiled criticism of the Government's decision to raise the national minimum wage by 6 per cent this year, saying it was pushing up wages demands in the rest of the economy. "The national minimum wage is reaching levels where anecdotal evidence shows that it is affecting bargaining for those above the minimum," he said. The Bank also said import costs were rising at their strongest rate for five years, while surveys suggested fresh recruitment drives by companies would take place in coming months.

However, Mr King moved to stem some of the more hawkish views coming out of the City insisting that the inflation report was not a guide to future interest rates. "It's a mistake to try and get into this business of nods and winks of where interest rates may or may not go," he said. "There are still risks on the downside associated with the impact of strong energy and import price inflation on real disposable incomes and consumer spending."

Analysts in the City were split over the implications. Alan Clarke, a UK economist at BNP Paribas, said it flagged up one more rate rise with an evens chance of a second one next year. "It begs the question - why didn't they hike in May?" he said.

But Nick Stamenkovic, the senior economist at RIA Capital Markets, said: "It's a case of steady as she goes. There was a clear message from Mr King that the Bank is happy to stay on the sidelines for the time being."

In a wide-ranging press conference, Mr King warned that house prices looked "remarkably high" but played down fears of a mini-boom saying the evidence of the "last month or two" had pointed to a slight slowdown in mortgage approvals. He also added his voice to the growing concern over insolvencies, which hit a fresh record of 23,000 in the first quarter.

Mr King said this was equivalent to one-fifth of 1 per cent of the adult population getting into "serious trouble" every year.

"For those who think bankruptcy and insolvency are a very traumatic event it is a relatively high figure," he said.

Governor says trade gap not sustainable

Mervyn King, the Governor of the Bank of England, warned yesterday that Britain's trade deficit with the rest of the world was not sustainable as figures showed that the gap narrowed in March for the first time in five months.

Official figures showing that the goods trade gap fell from a record £7.05bn to £5.46bn will boost hopes that the long-awaited rebalancing of the UK economy is under way.

But the Bank warned the UK could not continue to run such large shortfalls indefinitely. Mr King said: "It's not likely to be sustainable that we can run a trade deficit that is 4 per cent of GDP - which is where we are now."

Figures from the Office for National Statistics showed the deficit on goods and services was 3.7 per cent in the final quarter of last year although the goods shortfall alone was much higher at 5.6 per cent. The ONS data showed the narrowing was driven by a pick-up in exports to countries outside the European Union and fewer goods being imported from around the world. Exports rose 2.3 per cent to £20.3bn while imports fell 4.2 per cent to £25.8bn. Sales to the rest of the EU dropped 4.3 per cent, denting hopes that UK industry could takeover advantage of the economic rebound on the Continent.

The improvement in March was not enough to offset the impact of the record shortfall in February. The quarterly deficit came in a record £18.9bn. "The figures will prove a welcome respite from the deteriorating trade figures witnessed over the past few months," Simon Wallace, at CEBR, said. "However one must remain cautious as the rising value of the pound against the dollar at the end of April could negatively hit the trade balance."