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Bank of England seen holding rates as economists predict a spike in UK inflation

The Bank of England (BOE) is widely expected to leave interest rates on hold Thursday at a record low of 0.25 percent on the back of U.K. economic strength outpacing expectations in the wake of the EU referendum.

The U.K.'s central bank is also seen maintaining the targets for its ongoing asset purchase facility (APF) - its quantitative easing program - at current levels of £435 billion ($537 billion) for U.K. government bonds (gilts) and "up to" £10 billion for corporate bonds.

Since Governor Mark Carney's recent clarification that he would extend his 2018 end date by one year - a timing which may cover the U.K.'s two-year exit period from the European Union - the focus of Thursday's press conference has turned to the bank's view of the country's economic health.

One important ingredient in forming this outlook will be the bank's inflation forecasts, set to be unveiled in its November inflation report at 12:00 p.m. London time. Inflation data reported since the previous report was delivered in August has spiked, alongside a plunge in sterling.

Gross domestic product (GDP) also put in a strong performance in the third quarter, with the 0.5 percent figure recorded soundly beating expectations of a 0.3 percent rise and trouncing the BOE's revised estimate from August of 0.1 percent.

Inflation to overshoot?

City workers walk past the Bank of England in the City of London, Britain
Toby Melville | Reuters
City workers walk past the Bank of England in the City of London, Britain

In light of these strong figures, analysts across the board have upped their expectations for inflation in 2017 and beyond significantly higher.

According to the National Institute of Economic and Social Research (NIESR), inflation is likely to soar to 4 percent in late 2017 and only work its way back down to the Bank of England's 2 percent target in 2020. This exceeds the BOE's latest estimate of inflation that would peak and flatline at 2.4 percent from the fourth quarter of 2018 until the end of its forecast horizon in the third quarter of 2019.

However Adrian Lowcock, investment director at asset manager Architas, says any jump in inflation is likely to be short-lived.

According to Lowcock, "Looking beyond the short term inflationary pressures we do not expect inflation to remain high. The pound and the oil price have both stabilized so their effect on inflation will be temporary."

"There is still little sign of domestic inflation through wage growth as companies are continuing to look at cutting costs to boost earnings," he added.

In explaining its decision to cut rates in August, the BOE warned another cut could be on the horizon for 2016 if data proved "broadly consistent" with its gloomy predictions for the U.K. economy in the near-term following the Brexit vote.

According to Kallum Pickering, senior U.K. economist at Berenberg Economics, "The BOE's decision to provide extra liquidity around the vote and then to announce a suitably large monetary stimulus in response to the sharp downgrades in the market's assessment of the U.K.'s economic outlook was appropriate. But the U.K.'s better-than-expected economic performance since the vote has removed the need for the BOE to act again."

Pickering says he is looking to the bank Thursday to both update its view of the economy and provide comfort to the market that it is on guard if the Brexit impact does begin to filter through to data.

"We expect the BOE to use (Thursday's) November inflation report as an opportunity to take stock on the state of the economy and the effectiveness of its policies, while sending a strong signal that the BOE stands ready to do more if economic conditions were to deteriorate."

"We will be looking closely at the BOE's assessment of the forthcoming inflationary headwinds to consumption, the impact of 'hard Brexit' fears on investment, and, if any, the policy implications of the recent weakening of sterling," he added.

Brexit impact to come?

While data gathered in the immediate aftermath of the referendum have proved surprisingly resilient, many still expect deeper negative effects on the economy will take time to filter through.

According to Brian Hilliard, U.K. economist at Société Générale, the BOE was early in its predictions rather than widely off-target.

"We still think the Bank is correct to believe that a big hit to growth will come eventually from the Brexit uncertainty, requiring further easing in due course," he said.

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