BOE Sees Real Risk of High UK CPI Inflation, May Rise to Near 4% Over 2008 (Update)

BOE Sees Real Risk of High UK CPI Inflation, May Rise to Near 4% Over 2008 (Update)
(05/14/08 07:59) (CEP News) London The Bank of England delivered a stark warning on Wednesday that the UK faced a real risk of inflation rising well above the target rate of 2% to nearly 4% by the autumn of 2008 before the scenario improves. In its May Quarterly Inflation Report, the UK Central Bank said the inflation picture remains grim even though it has nearly halved projections for the country's economic growth. BOE's base case scenario is that the annual CPI inflation rate is likely to rise to around 3.5% to 3.7% by autumn 2008, chiefly on account of rising energy costs, provided that market projections on benchmark UK rates ring true. However, a regulation fan chart (contained in all inflation reports) for May indicates the BOE is worried that inflation could touch 4%, a clear rise from the fan chart contained in the February inflation report. Furthermore, the BOE projects that if UK rates are left at 5.0%, inflation could fall to the 2.0% target, while GDP growth would fall below 1% in 2008. The bleak assessment of the inflation picture makes a regulation letter from BOE Governor Mervyn King to UK Chancellor Alistair Darling a near certainty, as the CPI measure is forecast to rise above its current 3% rate seen in April. BOE believes the UK economy is at risk of stalling. However, even though one to two quarters of negative growth are expected, the report does not suggest the UK risks going into a recession as a result of the credit crisis. Inflation report projections suggest that GDP growth could fall to an annualized rate of 1% or below by December 2008, despite expectations of a weaker pound sterling boosting the country's exports. A recovery to around 2.5% is not expected before two years, based on the benchmark rate falling from the current 5.00% to 4.50% within 12 months. In summation, the inflation report suggests that risks to inflation are on the upside, while those for GDP growth are to the downside, over the short to medium term. It said further that Monetary Policy Committee (MPC) will be monitoring a range of data, between now and the publication of the next inflation report in August. "The Committee will concentrate on surveys of household inflation expectations and companies' pricing intentions, measure of inflationary pressures in the supply chain and data on wages and earnings," it said. MPC would place particular emphasis on price and quantity of credit, asset prices, consumer and corporate spending, energy and food prices. Value of the pound sterling would also be studied in the run-up to August. Elsewhere in the report, the BOE said both UK residential and commercial property markets were taking a hit amidst the ongoing tightening of credit availability. The central bank described the link between house price rises and consumer spending as a complex one. The report mentions that lower house prices do not implicitly mean lower consumer spending.
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BOE Sees Real Risk of High UK CPI Inflation, May Rise to Near 4% Over 2008 (Update)

However, it notes that, "The impact on consumption could be further amplified if lower house prices coincided with a period of markedly lower income growth, for example if companies begin to shed labour." Within an hour of publication of the inflation report the pound sterling paradoxically suffered. It dipped below the US$1.93 mark for the first time since early March. Conventionally, rising inflation boosts a currency, as chances of benchmark rate cuts lessen. However, London based forex traders stated that the markets are doing just the opposite amidst fears of a sharp UK economic slowdown, after the May inflation report highlighted some of the BOE's worries. At 5:15 a.m. EDT on Wednesday, the Pound Sterling-US Dollar cross fell to US $1.9399 from US$1.9427. Mark Priest, senior trader at TradIndex, said, "We've seen a wave of bad news this (Wednesday) morning, including the BOE's gloomy inflation forecast which has hit the pound. Furthermore, a sharp rise in unemployment data (published by the ONS) suggests that the credit crunch is beginning to bite in the wider UK economy." Meanwhile, economists believe the BOE's latest inflation projections effectively end the chances of a June interest rate cut. Jonathan Loynes, chief European economist and director at Capital Economics, said, "We still think interest rates will eventually fall considerably further as the economy continues to weaken and inflation concerns finally fade. But a June cut now looks pretty unlikely and any further loosening will be modest in the foreseeable future - seriously bad news for the economy." By Gaurav Sharma, gsharma@economicnews.ca, edited by Cristina Markham, cmarkham@economicnews.ca (END) CEP Newswires - CEP News Ltd. 2008. All Rights Reserved. www.economicnews.ca

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