UK inflation will hit its 2% target in two years assuming interest rates rise very gradually as implied by the market yield curve, the Bank of England forecast today.
The central bank's quarterly Inflation Report showed CPI inflation rising in the near-term on the back of higher energy and import costs before falling back to around the 2% target in two years.
'The central projection is for CPI inflation to move above the target over the next year or so and then fall back to the 2% target at the two-year horizon,' BoE Governor Mervyn King said.
Some Monetary Policy Committee members, however, thought that inflation would be little higher while others thought it would be lower. They agreed the risks were broadly balanced.
The BoE said that CPI inflation would also be a little higher if interest rates remained steady at 4.5% throughout the forecast period. It said the market yield curve implied that interest rates would rise gradually to 4.6% by the end of the year and to 4.7% in the second quarter of 2007.
Many economists and traders had in recent days assumed that interest rates would rise at a sharper pace sooner, perhaps even as early as September.
The BoE report may boost expectations that interest rates are not about to change soon but that the next move will indeed be up. Many economists had been holding out for another cut this year.
On GDP, the central bank said that growth was likely to stay close to its long-run average over the next three years, underpinned by steady expansion in consumer spending. The risks to this forecast were broadly balanced but the profile was described as slightly weaker than in February.
The MPC noted a pick-up in inflation expectations, perhaps related to higher utility bills, but said there was little evidence that this was sparking higher earnings growth.
The BoE's Monetary Policy Committee held interest rates at 4.5% for the ninth month in a row last week. Only eight members were present at last week's policy meeting as the Treasury has yet to appoint a replacement for Richard Lambert who stepped down suddenly in March.
