Wednesday May 14, 10:47 AM
BoE sees high risk of UK CPI inflation rising to near 4 percent by autumn 2008
LONDON (Thomson Financial) - The Bank (TBHS - news) of England has warned that inflation could rise up to 4 percent this year, more than two percentage points above target, even though it has effectively halved its predictions for economic growth.
In its quarterly Inflation Report, the central bank said its base case scenario is that the annual CPI (NYSE: CPY - news) inflation rate is likely to rise to around 3.6 percent this autumn because of higher energy and import costs -- subject to interest rates moving as the markets currently expect.
However, its fan chart, which shows the range of forecast probabilities, suggests that there's a real chance it could rise to 4 percent or even higher, a marked pick-up from the previous BoE projections in February.
If rates are left where they are, then inflation is seen falling to the 2.0 percent target, while GDP growth would fall below 1 percent this year and only recovering to just above 2 percent in two years time.
Whatever materialises, it looks like a dead-cert than the central bank's governor Mervyn King will have to write a letter to Chancellor of the Exchequer Alistair Darling explaining why inflation has risen by more than a percentage point above the 2 percent target. Figures for April, released yesterday, showed CPI inflation running at just short of letter-writing territory at 3 percent.
As if the inflation spike doesn't present enough problems, the BoE also warned that the UK economy is in danger of grinding to a halt this year, and possibly sinking into recession, as a result of the crisis in credit markets.
It said there is a high risk that GDP growth could fall to an annualised rate of 1 percent by the end of this year, the lowest levels since the early 1990s recession, even though the weaker pound should boost exports.
Its central projection is that growth will continue to moderate this year towards the 1 percent level before recovering at the start of next year, rising to around 2.4 percent on the two-year horizon.
The BoE's forecasts are based on the benchmark Bank Rate falling from the current 5.00 percent to 4.50 percent in a year's time, rising 4.60 percent the following year.
The BoE's latest economic projections clearly illustrate the dilemma it faces on interest rates. While above-target inflation would, under normal circumstances, indicate that borrowing costs have to rise, a stalling economy should herald lower rates.
Overall, the central bank conceded that risks to inflation rare on the upside, while those for growth are to the downside, at least in the medium-term.
It said that the rate-setting Monetary Policy Committee will be monitoring a range of data, in particular the extent to which above-target inflation becomes embedded in the economy.
'The Committee will concentrate on surveys of household inflation expectations and companies' pricing intentions, measure of inflationary pressures in the supply chain and data on wages and earnings,' it said.
On growth, it said the key risks come from the weakening in real income growth as a result of above-target inflation and tighter credit both in the UK and abroad.
In gauging the extent of tightening in credit conditions and its impact on demand, the BoE said the MPC (A050540.KQ - news) will focus particularly on the price and quantity of credit, asset prices, timely indicators of household and corporate spending, energy and food prices, UK import prices and the value of the pound.
Though the BoE suggested that lower house prices do not in themselves mean lower consumer spending, it warned that a sharper fall than the one currently being seen could make it more difficult for households to find credit.
'The impact on consumption could be further amplified if lower house prices coincided with a period of markedly lower income growth, for example if companies begin to shed labour,' it said.
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