Bank of England Indicates Scope for Rate Cuts Limited

Bank of England Indicates Scope for Rate Cuts Limited

Feb. 13 (Bloomberg) -- The Bank of England raised its inflation forecast and signaled policy makers may need to keep interest rates higher than investors currently predict.

Inflation will overshoot the central bank's 2 percent goal in two years and risks breaching the government's 3 percent limit before then, the bank said in London today. The bank based its forecasts on investors' bets for the benchmark interest rate to fall to 4.5 percent by the end of the year.

The pound rose and rate futures climbed. Bank of England Governor Mervyn King is weighing the need for further rate cuts after the bank reduced borrowing costs last week for the second time in three months to cushion the economy from a slowdown. While the U.S. Federal Reserve lowered its benchmark at the fastest pace since 1990 last month, U.K. policy makers have been more cautious as they seek to control inflation.

``Inflation is, in the medium term, more likely to be above the target than below'' if rates fall as investors forecast, King told reporters in London today. King said it's ``odds on'' inflation will exceed 3 percent and he'll have to write a letter of explanation to Chancellor of the Exchequer Alistair Darling.

The pound rose as much as 0.2 percent to $1.9655 in London and traded at $1.9638 at 11:12 a.m. in London. Rate futures also increased, with the implied yield on the contract maturing in December climbing 5 basis points to 4.69 percent.

The Bank of England on Feb. 7 cut the benchmark rate by a quarter-point to 5.25 percent.

Predicament

King expects a ``marked slowing'' in growth and the central bank cut its forecast, predicting the pace will trough at about 1.6 percent late this year. In November, the bank predicted the expansion would slow as far as 2 percent in 2008. The bank releases forecasts in the form of fan charts instead of specific numbers.

``The inflation report underlines the bank's predicament,'' said Christoph Rieger, an economist at Dresdner Bank AG in Frankfurt. ``The projected growth slowdown is somewhat deeper and more prolonged than in November. Overall, the report may prevent the Bank of England from easing more aggressively in the near- term.''

The Bank of England's benchmark will reach 4.5 percent by the end of the year, according to the median forecast of 44 economists in a Feb. 1 Bloomberg News survey.

Faster Inflation

Inflation accelerated to 2.2 percent from a year earlier in January, the most since June, compared with 2.1 percent in December, the Office for National Statistics said yesterday in London. Producer prices rose 5.7 percent from a year earlier, the quickest pace since 1991, data showed Feb. 11.

Rising energy and food costs have prompted some central banks to increase rates even after the Fed last month cut its benchmark by 125 basis points to 3 percent. Swedish policy makers lifted their key rate to 4.25 percent today, the Reserve Bank of Australia on Feb. 5 raised its benchmark to 7 percent and Group of Seven officials meeting in Tokyo on Feb. 9 said they're concerned about ``heightened inflation expectations in some countries.''

Some economists said the growth slowdown will force the bank to keep cutting.

``The message the bank would like to get across to the market is that there is only room for moderate easing ahead, but the fundamentals say otherwise,'' said David Brown, chief European economist at Bear Stearns International.

`Balancing Act'

U.K. retail sales will drop this year as consumer spending weakens, increasing the number of bankruptcies in the industry, London-based market researcher Verdict Research said. The housing- market slump deepened in January to the worst since the British economy emerged from its last recession in 1992, the Royal Institution of Chartered Surveyors said today.

``It's possible there will be falls'' in house prices, said King. The bank faces ``a difficult balancing act'' as it tries to control inflation while preventing growth grinding to a halt, he said.

At the same time, King urged economists and investors to steer clear of ``doom and gloom'' when assessing the slowdown. U.K. unemployment fell for a 16th month to a three-decade low in January, the Office for National Statistics said today.

``If you look at the facts, we've seen unemployment falling and growth for the fourth quarter was 0.6 percent, which is very close to long-run average growth rate of the U.K. economy,'' he said. ``I would encourage you to present a balanced picture.''

BLOOMBERG