Bank of England sees sharper inflation and slower growth in 2017

The UK economy is likely to grow slightly more slowly and inflation increase more sharply than the Bank of England initially expected, it said on Thursday as it otherwise left its main policy levers unaltered.

In the Bank's quarterly inflation report, the Monetary Policy Committee raised its 2017 consumer price inflation forecasts to 2.7% from 2.4% due to increased import costs due to the fall in the pound since the Brexit vote.

With rising inflation combining with stuttering wage growth to put the squeeze on UK consumers sooner than the MPC had anticipated, the MPC also slightly revised down its gross domestic product growth forecast for this year to 1.9% from 2%.

But the committee nudged up its forecasts for 2018 and 2019 to 1.7% and 1.8% from 1.6% and 1.7%, respectively, but it warned that these projections assumed a “smooth” Brexit transition.

However, the Bank reduced its forecast for inflation in 2018 and 2019 to 2.6% and 2.2% respectively, from 2.7% and 2.4% previously due to the recent strengthening of the pound and softening in oil prices.

Judging inflation was overshoot its 2% long-term target solely due to sterling’s depreciation, the committee mostly felt there is no need to raise rates yet.

Once again, this was not the opinion of externally appointed MPC member Kristin Forbes, who as she did in March dissented by voting for a hike of the bank rate to 0.5% due to her concerns about inflation. The ex White House economic adviser is due to leave at the end of June, though.

Her influence may have had an effect, as the MPC's tone was more hawkish than last month, saying the UK may need a tighter policy that the yield curve currently implies.

The inflation report added support to the view that interest rates are set to rise sooner than markets expect, said Paul Hollingsworth at Capital Economics.

"Note that the MPC stated that interest rates may need to rise by a 'somewhat greater extent than implied by markets' – the forecasts are based on rates rising in Q4 2019, although markets have pulled their expectations forwards to Q1 2019 in recent days.

"If we are right in thinking that the economy will maintain a solid pace next year, rather than slow as the MPC expects, then we think that the Committee should be in the position to take the first steps in “normalising” monetary policy around Q2 2018."

Sam Tombs at Pantheon Macroeconomics red the runes differently.

"Revisions to the MPC’s forecasts suggest that it thinks the case for raising interest rates to cool inflation has weakened since its last Inflation Report," he said.

He added that the minutes showed that despite these revisions, 'some' members besides Ms Forbes continued to note that it would take “relatively little further upside news on the prospects for activity or inflation” for them to consider immediately hiking interest rates.

While the MPC warned that interest rates would need to rise to a slightly greater extent than implied by the current market yield curve, if the economy evolved in line with its projections, Tombs said the much lower forecast for inflation in two years’ time "speaks for itself" and he continued to think that the MPC won’t raise interest rates "until at least Brexit has occurred in early 2019".