The Bank of England raised its medium-term inflation forecast to just under 2 percent in its May inflation report, potentially paving the way for a November rate rise.
The BoE based its quarterly forecasts on the assumption that market interst rates rise to 0.8 percent in the last three months of this year and reach 1.0 percent in early 2012 — a slightly faster pace of tightening than currently priced into money markets.
The central bank said the near term outlook for inflation had worsened and that consumer price inflation was likely to reach 5 percent in the short term due to higher energy costs.
"There is a good chance that inflation will reach 5 percent later this year, and it is more likely than not to remain above the 2 percent target throughout 2012," the BoE said.
The BoE said that the chances of inflation either exceeding or undershooting its 2 percent target in the medium term were judged to be roughly balanced — though a chart showed that the odds had moved slightly in favour of an overshoot.
Before the BoE report, money markets were only fully pricing in a first quarter-point BoE rate rise for early 2012, though many economists expected an earlier move.
The BoE has held rates at 0.5 percent since March 2009, but the nine-member Monetary Policy Committee has been split for months about whether to raise rates. Three members voted for a rise in April.
"The range of views among Committee members over the outlook for inflation is wider than usual. In the current uncertain environment, modest differences in judgements ... can have a material impact on the outlook," the BoE said.
The BoE said that the near-term outlook for growth had worsened since February, and that first-quarter growth had been slower than it had predicted — even if though it was likely that official GDP data was underestimating the strength of the economy.
It also said that the extra public holiday in April to mark the Royal Wedding, and disruption to supply chains from the Japanese earthquake were likely to make quarterly GDP growth rates more volatile than normal.
At the two year horizon, it saw annual growth of just under 2.9 percent — lower than the 3.1 percent it predicted in February.