Inflation warning from Bank

THE BANK of England said yesterday that the Government's preferred measure of inflation could break through the top of its target range this year and that there was no case for another cut in interest rates for the time being.

The Bank did not explicitly warn against another cut in base rates at the time of the Budget, but implied that there would have to be fresh reasons to justify it. These might include tax increases or spending cuts, a stronger pound or renewed economic weakness.

In its first quarterly report on the Government's anti-inflation policy, the Bank said that the underlying rate of price increases - excluding mortgage interest payments - was likely to be between 3 and 4 per cent in the next couple of years, with more danger of overshooting than undershooting.

The Bank warned that the Government had not yet convinced the public and financial markets that it would stick to its inflation target. The Chancellor has set a target of 1 to 4 per cent for underlying inflation, which last month fell to 3.2 per cent.

'Such a target range would mean that at this stage of the cycle inflation would be expected to be nearer 1 per cent than 4 per cent. The reverse is the case. This demonstrates that there is still some way to go before the underlying inflation rate is consistent with the objective of price stability,' the Bank said.

It warned that excessive Government borrowing could undermine the credibility of policy, because of the fear that inflation would be used to reduce its value. It added that not all government borrowing could be blamed on recession, implying that tax increases would be needed.

The Bank believes that government debt could rise as a proportion of national output in the long- term if the recession has reduced the economy's capacity to expand.

Last month's unexpectedly large fall in the headline rate of inflation to a 25-year low of 1.7 per cent came after the report was completed. But the Bank believes that the recent weakness of the pound in raising import prices more than offset the good news in the January figures.

'A sustained further sterling depreciation could lead to inflation above the top of the target range,' the Bank said.

The Bank believes the economy is still bumping along the bottom. It expects that national output fell slightly in the last three months of the year, excluding North Sea oil production.

The Chancellor announced that the Bank would produce quarterly reports on inflation in last year's Mansion House speech as part of moves to greater 'openness' in economic policy.