UK interest rates are unlikely to fall as much as markets expect to stem an economic slowdown, the Bank of England signalled yesterday in a hawkish inflation report, warning of "substantial challenges for policy" this year.
In its quarterly update on the outlook for the UK, the bank predicts that tighter credit conditions, slowing investment and reduced consumer demand could lead to a "deeper and more persistent" slowdown than it expected in November.
The outlook came as Sweden's central bank surprised markets by raising interest rates by 25 basis points to 4.25 per cent, saying that inflation "is expected to be high, while economic activity remains good". Like the UK, Sweden is a member of the EU but not the eurozone.
In the UK, according to market expectations, growth would slow to well below 2 per cent before recovering gradually from the fourth quarter of 2008. However, rising food, energy and import prices are likely to push inflation sharply above target, whatever happens to interest rates.
The bank, which is mandated to keep consumer price inflation about 2 per cent in the medium term, believes that if interest rates were held at 5.25 per cent, inflation would fall below target in two years' time.
