The Bank of England on Wednesday signalled the next move in interest rates was likely to be up as the US Federal Reserve raised its main interest rate to 5 per cent.
The Bank’s quarterly inflation projections indicated inflation would overshoot its 2 per cent target if it failed to raise rates.
The Fed’s move was the 16th in a row since June 2004 and was accompanied by a statement indicating that it may have to raise rates further, although future moves would not be automatic.
“The extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information,” the Fed said.
With the Bank of England now expected to raise rates, all the world’s important central banks are tilted towards tightening.
The inflation report shows inflation on target in two years’ time if rates rise by close to 0.5 percentage points over the period, reflecting a reassessment of the cost and price pressures in the UK economy.
Mervyn King, Bank governor, said: “Since the February report, the prices of oil and other commodities such as metals have risen further…[and] pose upside risks to inflation.”
Though higher energy prices were expected to have only a temporary effect on inflation, longer-term pressure on inflation would come from scant spare capacity among businesses and slower declines in import prices, according to the report. Mr King also said there was anecdotal evidence that recent rises in the national minimum wage were beginning to have a knock-on effect on wage bargaining further up the earnings scale.
Though the Bank refused to give specific guidance regarding rates, the majority of analysts and investors took the report as a signal that the next move would be up.
Danny Gabay of Fathom, the economics consultancy, said: “This will be seen as a heavy hint that unless rates do rise from 4.5 per cent, inflation is likely to overshoot the target. That clearly marks a shift in the committee’s thinking, which judging by the minutes and the voting pattern of recent meetings, has until now been far more focused on whether or not to cut rates.”
Interest rate expectations in money markets fell on the report, since they had already begun to price in two or three quarter-point rate rises.
Some investors had expected the Bank to produce a more optimistic growth forecast but in the event it in fact pared back its growth expectations. Michael Saunders of Citigroup estimated the Bank now expected growth of about 2.4 per cent this year and 2.8 per cent in 2007.
The Bank said that a pick-up in business investment and greater demand for exports would offset weaker public spending and consumer expenditure growth.
Mr King described the risks both to inflation and growth as broadly balanced.
“The downside risks to activity in the world comes from the change in the global imbalances, which might involve either big changes in exchange rates or indeed a recession in world demand,” he said.
Some analysts questioned why the Bank, given its new concern over inflation, had not already raised rates.
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