Analytics
The best Experts' Views, Marks and Forecasts on Economics >>
-
16 February 2011
Bank Inflation Report to pave way for rate hikes
Fiona Shaikh, 0:03, Wednesday 16 February 2011
LONDON (Reuters) - The Bank of England is likely to smooth the way for higher interest rates with its quarterly economic forecasts on Wednesday, to tackle inflation that is currently running at double its 2 percent target.
But the central bank's Inflation Report forecasts will also highlight the huge uncertainty about where the economy is heading and policymakers are likely to be reluctant to set themselves too rigid a course for monetary tightening.
The Bank has held interest rates at a record low 0.5 percent for almost two years but investors are betting the central bank will start raising rates as early as May to bring inflation back to target over its two-year forecast horizon.
In an obligatory open letter to the government on Tuesday, Bank Governor Mervyn King said inflation was likely to rise to between 4-5 percent in the short term and that it was just as likely to be above target as below it in two to three years time if interest rates rise in line with market expectations.
"The Governor's letter seems to endorse market pricing for the Monetary Policy Committee to hike soon," said Citi economist Michael Saunders.
Money markets are pricing in rates at 1.25 percent by the end of this year, and in general expect a faster pace of tightening over the next two years than they did in November (Berlin: NBXB.BE - news) .
However, most City economists do not expect the central bank to start tightening policy until much later this year, highlighting the dilemma facing policymakers of how to tackle rising price pressures without derailing the economic recovery.
Consumer price inflation hit a two-year high of 4.0 percent in January, up from 3.7 percent in December.
"The committee has no choice but to establish its credibility by sounding hawkish," said Amit Kara, economist at UBS (DJCI - news) .
The Bank produces two forecasts for inflation -- one based on market interest rate expectations and one that assumes interest rates remain at 0.5 percent.
Analysts reckon that near-term inflation forecasts on both measures will be revised upwards to reflect a greater knock-on impact of rising commodity prices and value-added tax.
The November forecasts envisaged inflation falling to a modal 1.45 percent in the fourth quarter of 2012 based on market rate expectations, and 1.59 percent based on unchanged policy.
"For the first time in a while, assessing what happens to monetary policy will depend on both fan charts," said Alan Clarke, economist at BNP Paribas (BNPQF.PK - news) .
GROWTH RISKS
The Bank's outlook for growth will also play a key role in determining when policymakers start to withdraw monetary stimulus, and so far it has maintained there is enough slack in the economy to keep inflation in check further down the line.
The central bank will almost certainly have to revise down its near-term forecasts for GDP from November because of the shock 0.5 percent quarter-on-quarter decline in economic output in the final three months of 2010.
The contraction was mainly due to heavy snowfall in December, and there are signs that activity rebounded quickly in January.
But the Bank may still have to lower its medium-term outlook for growth, lessening the urgency for the MPC (050540.KQ - news) to take action on inflation.
The Bank's modal projection for year-on-year GDP growth in Q4 2010 was 3.05 percent -- almost double a first official estimate of 1.7 percent growth.
"That said, most MPC members have clearly become more worried about the damage to credibility that is being wrought by the persistent overshooting of the inflation target," said Simon Hayes, economist at Barclays Capital.
"In that case, the report will provide a vehicle to prepare financial markets, firms and households for a rate hike, probably within the next few months."
(Reporting by Fiona Shaikh; editing by Stephen Nisbet)
