Lorik blog

BoE forecasts pave way to rate rise, King more cautious

LONDON (Reuters) – British inflation is just as likely to be above or below target in two years if interest rates rise as markets expect, the Bank of England said on Wednesday, opening the door to tighter monetary policy.

But BoE Governor Mervyn King insisted that no decision about when to raise rates had been taken.

"Some people are running ahead of themselves and saying that we are pre-announcing or laying the ground for a rate rise," King told a news conference. "That decision has not been taken and won't be taken until we get to the next meeting or the following meeting, or it may be many quarters."

The Bank's inflation report supported expectations the BoE will start hiking rates soon from a record low 0.5 percent, possibly as soon as May, given that inflation is double its 2 percent target and likely to climb further.

The central bank's February report showed consumer price inflation spiking up to between 4 and 5 percent in the middle of this year before falling back to around 1.7 percent in early 2013, a higher forecast profile than in November.

Rising price pressures have already prompted investors to bet on a series of UK rate hikes this year.

But having jumped on Tuesday after data showed UK inflation rose to 4 percent in January and King wrote a letter to the government saying price pressures could fall into line if rates rise as markets predict, the pound fell back after King began speaking.

"It looks as though markets may have over-interpreted King's line on inflation in yesterday's letter to the Chancellor," said Philip Shaw, economist at Investec. "The picture painted by the inflation report is balanced and emphasizes the uncertainties."

The Bank said its forecasts were based on the assumption that interest rates would rise to 1 percent by the end of this year, hitting 2.1 percent at the end of 2012.

"Our judgment is that along that market path of interest rates the risks to inflation in the medium term are broadly balanced around the target," King said.

But he stressed that the central bank was not in the business of endorsing market expectations.

DIFFERING VIEWS

King admitted there were sharply differing views on the Monetary Policy Council of interest rate setters.

"There remains a wider than usual range of views among Committee members over the outlook for inflation," he said.

Minutes to January's policy meeting showed two MPC members voted to raise rates that month, indicating a shift toward a more hawkish stance. The evidence from February's meeting will be published next week when the vote could have been even tighter.

The Monetary Policy Committee predicted a bumpy ride for the economy this year, with its 2011 forecasts for growth lower than those in its November quarterly forecasts, but it is seen picking up to around 3 percent in the medium term.

"Expansionary monetary policy, combined with further growth in global demand and the past deprecation of sterling should ensure that the recovery in the UK is maintained," the BoE said.

"But the continuing fiscal consolidation and squeeze on households' purchasing power are likely to act as a brake."

That economic uncertainty led some economists to believe that markets are too hasty in pricing in a May rate rise with sharp government spending cuts only beginning to bite.

"We still think a move as early as May is less likely than one in H211 as the Bank will be keen to assess, for example, what impact the aggressive fiscal retrenchment will have on activity before it tightens monetary policy," said Hetal Mehta at Daiwa Capital Markets. "On balance, we feel the first rate hike is most likely to come in August."

(Editing by Mike Peacock)