Bank rules out imminent rate rise: Inflation outlook more optimistic - Stock market enjoys best day since November Budget as Footsie soars
THE BANK of England dispelled fears of an imminent rise in interest rates yesterday, saying it was more optimistic than in May about the outlook for inflation until the end of next year. But the Bank still believes rates must rise if the Government is to hit its inflation target.
The City reacted with relief to the Bank's quarterly Inflation Report, having expected a tougher warning. The December short-sterling contract rose to 93.49, suggesting that base rates would end the year up from their current 5.25 per cent to 6.5 per cent, although most economists believe the futures market is being too pessimistic.
The stock market had its best day since November's Budget, with the FT-SE index of 100 leading London shares rising by 60.1 points to end the day at 3,157.5. The pound also fell slightly.
'The Bank is suggesting that rates will rise, but not by much and not just yet,' said Geoffrey Dicks of NatWest Markets. He said the Bank was probably preparing the ground for a rise in rates in the last quarter of the year. Ian Shepherdson, of HSBC Greenwell, said rates would probably not rise until next year.
The Bank predicted that if interest rates were unchanged, underlying inflation was likely to fall a little further before gradually accelerating to above 2.5 per cent, the ceiling of the Government's target range for the end of this Parliament. 'It is possible the UK is entering a period where the pressure for higher inflation in the future may be building up even as the published inflation rate for the previous 12 months continues to fall.'
The Bank said it was more optimistic about inflation in the short term because the squeeze on profit margins had spread from food stores to other retailers, while the slack in the economy had done more to subdue price increases than it had thought. These effects, however, would be partly offset by robust economic growth.
Inflation could be pushed higher if commodity prices continued to rise rapidly, the Bank said, and the economy could be closer to full capacity than it looks. Senior officials are also concerned by the recent weakness of the pound.
But the Bank argued that the fall in the claimant unemployment figures might be exaggerating the tightness of the labour market and the upward impetus to average earnings growth.
It is conscious that changes in interest rates are likely to take around two years to have their full impact on the rate of inflation, which means that the last opportunity to influence inflation by the end of this Parliament will be in the second quarter of next year.
The Bank fuelled expectations of an imminent base rate increase last Friday, by raising the interest rate at which it accepted tenders for Treasury bills. But Bank officials believe the markets should have known Treasury bill tenders are almost never used to signal base rate changes.
View from City Road, page 27
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