British interest rates will need to fall in the coming months if inflation is to hit the central bank's 2 percent target in two years, the Bank of England signalled on Wednesday.
In its quarterly Inflation Report, the first formal assessment of the economic impact of the credit crunch, the central bank also cut its forecast for growth next year even if interest rates fall in line with market expectations.
The BoE predicted stronger price pressure in the near term because of higher energy prices and the depreciation of sterling, putting CPI above 2 percent for most of 2008 before it was seen easing back to the target by mid-2009.
Those forecasts are predicated on interest rates falling to 5.5 percent in the first quarter of 2008 and then 5.3 percent in the second half of next year. In early 2009, interest rates are seen coming down to 5.2 percent.
As such, the report boosted expectations that interest rates will be cut twice over the course of 2008 as slowing growth reduces inflationary pressures and sterling falls against the dollar and the euro.
Hint that Rates Will Fall
"Clearly it is a hint that interest rates will fall in due course," said Philip Shaw, chief economist at Investec The BoE said that risks to its inflation forecast were balanced but those to growth were on the downside.
But the BoE also believes that recent growth has been stronger than the official figures currently show.
There was, however, a lot of uncertainty over the outlook, particularly as the world financial system was still vulnerable to further shocks. Uncertainties abounded on asset prices, consumer spending and the global economy.
Monetary Policy Committee members also had a range of views on both the forecasts and the risks.
The BoE noted there were some signs of softening in house prices but said the link between the housing market and consumer spending was a complex one.
Using its normal methodology, the BoE forecast sterling's trade-weighted index falling to 101.0 in two years from a starting point of 102.6. The projection is lower throughout the forecast period than assumed in August.