London - Inflation will rise close to 3 percent by the end of next year thanks to the plunge in the pound and fears of a hard Brexit, according to the latest forecasts from the Bank of England yesterday. And in an indication that the Bank may be forced to jack up interest rates considerably sooner than markets currently expect the Bank’s Monetary Policy Committee (MPC) stressed “limits to which above-target inflation could be tolerated”.
The Bank warned the rise in inflation and the plunge in the currency was due to a “shock to future supply” in the UK economy brought on by fears the UK is now heading out of the EU single market. In its latest round of forecasts the Bank projects consumer price inflation rising to 2.7 percent in the final quarter of 2017, up from 2 percent in its August forecasts. And it sees inflation still at 2.5 percent in 2019. This is the biggest overshoot over three years relative to the Bank’s official 2 percent target the MPC has ever projected in an Inflation Report.
The current rate of inflation is 1 percent and many retailers have warned that prices of goods in the shops will soon have to rise due to the major jump in their import costs. Though the Bank said inflation expectations “remain well anchored” its stress on the “limits” to its inflation tolerance will send a hawkish message to the financial markets on the likely future path of its policy rate.
As widely expected, the nine-person Monetary Policy Committee voted unanimously to keep interest rates on hold at 0.25 percent. The Bank had previously signalled a further cut in its policy rate to 0.1 percent but the economy has performed considerably better than the Bank forecast in August, growing by 0.5 percent in the third quarter of the year, defying expectations the economy could fall into recession in the wake of the vote to leave the EU.
The Bank now expects this growth to continue, pencilling in a further 0.4 per cent of GDP growth in the final quarter of the year. It had previously forecast growth close to zero for the second half of this year. And it has upgraded its 2017 GDP forecast to 1.4 percent, almost double its August forecast of 0.8 percent.
Nevertheless, the overall cumulative growth forecast over the three year forecast period is still weaker than in August – which was itself a record cumulative growth downgrade – in an indication the Bank still firmly believes Brexit will inflict a serious negative toll on the economy.
The Bank said sterling’s lurch down against the dollar in October was due to market “perceptions that the UK’s future trading arrangements with the EU might be less open than they previously thought likely”. Sterling started falling again at the beginning of last month after the Prime Minister Theresa May indicated she would trigger the 2-year Article 50 EU divorce process in March 2017 and would prioritise controlling immigration from the EU. This is understood to imply Britain would have to leave the EU single market, usually described as a hard Brexit.
The Bank’s growth forecast in 2018 is 1.5 percent, down from 1.8 percent in August. And growth in 2019, the year the UK is expected to officially leave the European Union, is only 1.6 percent. The Bank still expects the unemployment rate to rise to 5.6 percent in 2018, up from 5 percent yesterday. It also expects business investment growth of just 2 percent in 2018, less than half the 4.75 percent growth it expected in August. It cited firms’ likely fears “their access to EU markets could be materially reduced”. The Bank expects the trade-weighted sterling exchange rate – which has fallen more than 15 per cent since the Brexit vote and 6.5 percent since October – to remain steady over the coming three years.
Many City economists, however, think the currency has considerably further to fall, something that would inevitably exert more upward pressure on domestic inflation. This week the National Institute of Economic and Social Research forecast that inflation will jump to almost 4 percent next year, well in excess of the Bank’s current projection.
Adam Posen, a former member of the Bank’s MPC, has voiced fears that a much bigger than expected increase in inflation could prompt the Bank to put up rates as soon as next May. The Bank said the “limits” on its toleration for inflation overshoots would depend on the cause of the rise, signalling if there were signs of inflation expectations becoming unanchored it would act.
The MPC also voted unanimously to continue with its £10bn corporate bond and £60bn Gilt buying programme designed to help the economy weather the Brexit vote. The Bank said the impact of its latest money printing programme had had a slightly larger impact on financial markets than it expected. In August, the Bank had said its monetary stimulus was one of the reasons the UK would avoid a return to recession.
THE INDEPENDENT