The Bank of England forecast the biggest sustained overshoot of inflation since it gained independence to set interest rates in 1997, and warned that there were limits to its tolerance of higher prices.
The pound's fall since the Brexit vote in June will raise import prices sharply, the bank's monetary policy committee (MPC) said, as it forecast inflation to exceed its 2 per cent target by next spring, peak at 2.8 per cent in early 2018, and stay above 2.5 per cent well into 2019, before returning to target only in 2020.
With inflation on the rise the committee has dropped its guidance that the next move in interest rates was likely to be downward. The committee indicated that they could move in either direction depending on the performance of the economy.
“There are limits to the extent to which above-target inflation can be tolerated,” the minutes of the November MPC meeting said.
The sharp rise in prices alongside a growing expectation of a damaging “hard Brexit” has left the central bank with a slightly gloomier outlook than it had in August, despite robust economic growth since the EU poll in June.
Its downbeat forecasts are bound to anger Conservative party Brexit supporters who complain that the bank has proved to be too pessimistic and is talking down the UK economy to justify its warnings about withdrawing from the EU.
The MPC admits that the post-referendum economy has been “notably stronger” than it expected, but urged caution, suggesting the good times will not last.
Four-week high
The bank’s forecast came on a day sterling surged to a four-week high after England’s high court ruled that the government needed parliamentary approval to trigger Brexit.
In the committee’s view, the hit to household incomes from higher prices and the damage from perceptions of a harder Brexit will more than offset the better data so far and the boost to exporters from a weaker pound.
With inflation projected to rise far above the bank’s 2 per cent target and stay above target for at least three years, the committee is becoming more worried that it will not be able to stick to its current view that it will “accommodate” the price rises and might instead have to raise interest rates to contain inflation.
The bank was careful not to give precise figures for the limit to its tolerance of high inflation.
It would depend on whether it was feeding into a spiral of further price rises and whether economic weakness was likely to restrain price increases, the Bank of England said.
The MPC said its guidance that the next move in rates was likely to be a cut "had expired". – Copyright The Financial Times Limited 2016
