UK interest rates will probably need to rise one more time for inflation to hit the 2 per cent target in two years, the Bank of England signalled yesterday.
The central bank's quarterly inflation report showed CPI inflation fractionally above the 2 per cent target in two years if interest rates rose in line with market expectations - another quarter-point to 6 per cent by the first quarter of 2008.
Inflation would clearly overshoot the target if rates stayed at their current 5.75 per cent, the report showed. The near-term profile for inflation, while clouded by recent wet weather, was higher than at the time of its May report, but further out was a little bit lower.
"Today's report is broadly consistent with our call for a final 25 bps rate hike in November, but next week's minutes will help to clarify the range of opinion on the monetary policy committee (MPC)," said Alan Castle, economist at Lehman Brothers.
The Bank of England has already raised borrowing costs five times but three policymakers opposed the last rise in July. Bank governor Mervyn King told a news conference after the report that differences on the MPC were not large.
He also stressed that the report should not be taken as a definite guide to what happens next with rates. "What is important is that we know what are the factors that will be important in driving our decision, and we try to explain in a clear way what the risks are."
Risks to inflation remained to the upside, the Bank of England said, but not as much as they had been just a few months ago as growth was now expected to be slower over the next two years.
The report showed GDP growth dipping toward 2.5 per cent in two years from about 3 per cent now. Risks to the forecast were balanced.
But the MPC is clearly worried that recent data are not accurately gauging the strength of the economy and could be revised upwards, possibly markedly.
The bank even provided a new chart showing what GDP would look like if this were to happen - stronger growth now and hence a sharper slowdown later.
Mr King said there were tentative signs that consumer spend- ing was slowing, but generally policymakers have been surprised by the resilience of the consumer and the housing market given rates have risen 1.25 percentage points since last August.
The bank did not appear unduly worried by the recent turmoil in financial markets but warned that if credit conditions tightened, there would be a downward impact on growth.
Mr King said the rise in credit spreads was a "welcome development" and so far this did not pose a major risk to the financial system.
