BoE sees UK Inflation Peaking at 4.8% by Year End

LONDON (Thomson Financial) - The Bank of England signalled today that interest rates in the UK will remain on hold for the coming two years if it is to bring inflation back to target even though the economy will be teetering on the edge of recession.

In its quarterly Inflation Report, the BoE said its central projection is for the annual CPI inflation rate to rise to 4.8 percent by the end of this year from the current 4.4 percent as food and energy costs continue to spiral. It then sees inflation dropping down to around 1.8 percent in two years, below its target of 2.0 percent, on base effect changes. The BoE said that its forecast included expectations of further utility price hikes in the coming months. The forecasts are based on market expectations for Bank Rate to rise to 5.1 percent by the end of this year from the current 5.0 percent, before falling modestly in 2009 to 4.9 percent and rising again to 5.1 percent at the end of the forecast horizon in two years time.

The Bank painted a pretty dismal picture of the economic outlook with both its inflation and growth projections worse than it predicted in May when it last published its economic outlook.

Though the BoE said its central projection is that the UK economy will not slide into recession for the first time since the early 1990s, it did place a 40 percent probability that growth will turn negative at the start of 2009.

"The outlook for the first part of the projection is noticeably weaker than in the May report," it said.

Its central projection is for GDP growth to fall to an annual rate of 0.2 percent at the start of 2009 before rising steadily for the remainder of the forecast period to around 2.4 percent, near the long-run average.

Again, the growth forecasts are based on market yields. The BoE said overall risks to its inflation projection are to the upside in the medium-term and the outlook "unusually uncertain".

On the upside, the BoE said the main risk is the possibility the period of above-target inflation prompts an increase in medium-term inflation expectations that feeds into wages and prices.

On the downside, the BoE said there is a possibility that higher energy prices and the credit crunch lead to "a deeper and more prolonged" period of subdued demand. Both set of risks have increased since the May Inflation Report, it added.

On growth, the BoE said risks are to the downside, especially in the medium-term.

"Sluggish real income growth and constraints on the ability of households to borrow dampen consumer spending, while the weak outlook for demand and the housing market lead to falls in business and residential investment," it said.

However, it said the fall in sterling and an anticipated recovery in the credit markets should fuel a pick-up in growth by the second quarter of next year. The BoE said there is a range of views among the nine members of the Monetary Policy Committe on both the central projection and the balance of risks. pp/rar/tfnloc COPYRIGHT Copyright Thomson Financial News Limited 2008. All rights reserved.

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