Bank of England forecasts lower growth and high inflation

In his opening remarks at the press conference to launch the report, Mervyn King, the Bank’s Governor, highlighted how these uncertainties mean that inflation could turn out higher than forecast (for example if commodity prices continue to increase at a rapid pace or if inflation expectations rise) or lower than forecast (if wage increases remain low and import price inflation fades).

The Bank of England’s latest Inflation Report, published today, forecasts slower real GDP growth in 2011, with inflation remaining above its 2 per cent target throughout the year – a disappointing combination for the second full year of economic recovery. However, as the report stresses, the outlook is particularly uncertain.

In his opening remarks at the press conference to launch the report, Mervyn King, the Bank’s Governor, highlighted how these uncertainties mean that inflation could turn out higher than forecast (for example if commodity prices continue to increase at a rapid pace or if inflation expectations rise) or lower than forecast (if wage increases remain low and import price inflation fades).

These uncertainties are reflected in growing disagreement among members of the Monetary Policy Committee. Although the majority continue to vote for no change in interest rates or in the scale of quantitative easing (QE), one member – Andrew Sentance – thinks it is time to start increasing interest rates, while another – Adam Posen – is arguing for an increase in the scale of QE.

Until the publication of figures showing the economy grew by a much faster than expected 0.8 per cent in the third quarter, it seemed that Posen might win the argument and a majority on the MPC would move in favour of an increase in QE. But strong growth seemed to have taken more QE off the agenda for a time.

The GDP numbers, however, only tell us what happened in the past. When framing monetary policy, the MPC are far more concerned with what is to come. Monetary policy is set with a view to where inflation will be in roughly two years’ time.

The central projection in the Bank’s inflation forecast, based on no change in interest rates or quantitative easing, shows it falling below its target rate of 2 per cent in 2012 and declining further as the year progresses. This could be used to justify more QE in order to bring inflation back up to target.

But not yet. For now, a majority of the MPC are likely to continue to believe that the uncertainties are so great that doing nothing is the best course of (in)action.

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