MPC split on inflation leaves puzzle over rates

THE MONETARY Policy Committee is split over the outlook for inflation, the Bank of England's latest Inflation Report revealed yesterday. The report left City analysts puzzling over what the lack of agreement would mean for interest rate moves during the next few months.

The confusion was reflected in the financial market reactions. The pound rose as the currency market concluded that interest rates were more likely to rise, but money market traders retreated from their earlier pessimism about rising borrowing costs.

The Bank has revised up its forecast for GDP growth, which it expects to reach 3 per cent in 2001. Its central forecast for inflation - which assumes rates stay unchanged at 5 per cent - shows a dip to below 2 per cent in the target inflation measure, before climbing sharply to pass 2.5 per cent in two years' time.

But not all MPC members agreed with the forecast, which would suggest higher interest rates are on the way. Mervyn King, the Bank's deputy governor, said: "The Committee found it more difficult than in the past to reach a common view on the outlook for inflation." He played down the difference of opinion, saying the nine members were agreed that inflation would fall in the near term and rise again later. "The message from the Bank of England today is encouraging: growth with low inflation is likely to be with us for some time," he said.

However, the detail of the Report showed some MPC members thought the target measure of inflation was likely to stay below 2 per cent for the next two years, while others thought it would be 2.75 per cent by mid- 2001.

This gap implies that some could even vote for further rate cuts in the next few months while others are already in favour of rate increases.

David Walton, an economist at Goldman Sachs, said: "There is a clear impression of a split at the last MPC meeting, and potentially we will get this for several more months." Minutes of the last meeting will be published next week.

John O'Sullivan at Greenwich NatWest said: "The committee of nine people is split into three camps and it is not clear whether any of them signs up to the published forecast. It is hard to be sure how this will play out."

The Inflation Report highlighted four key disagreements. Some thought the exchange rate would stay where it is rather than declining, worth 0.4 percentage points off the inflation forecast. Some believed in a continuing profits squeeze, taking 0.2 points off inflation. On the other side of the fence, some predicted the oil price would stay at $19 a barrel, adding 0.2 points. And stronger pay pressures than assumed would also add 0.2 points.

Although even next week's minutes will not identify individual votes, Mr King is regarded as the most hawkish, while DeAnne Julius is thought most likely to favour further rate cuts.