LONDON (AFX) - Underlying inflation (RPIX) in the UK is expected to stay at around 2 pct throughout 2001, before picking up gently to its 2.5 pct target, according to the Bank of England.
In its latest quarterly inflation report, the BoE said the pick-up in inflation will come as the moderating effect of past exchange rate appreciation wears off and pressures on supply generate a mild rise in wages and prices.
Overall, however, inflationary pressures are a little weaker than in the BoE's previous report due to lower global growth although these are partly offset by interest rate cuts, it said.
Members of the bank's monetary policy committee remain divided about supply side developments and international prospects, the bank said, adding that in combination these may lower inflation forecasts at the end of the 2-year horizon by up to 0.5 pct.
The bank conceded that there are considerable risks to its projections.
"In the committee's judgement, the risks to growth and inflation remain on the downside, associated particularly with the risk of a deeper or more prolonged slowdown in the U.S.", it said.
The outlook for growth is also softer than in the previous report, the bank said, citing the impact of the foot-and-mouth disease and slower consumption growth.
However, these factors are expected to be offset by a strong rise in public consumption and investment taking growth to around trend later on, it said.
The bank's central projection for 2001 GDP growth remains at 2 pct, going on the assumption that the bank repo rate stays at 5.25 pct. "The near-term outlook will continue to be affected by special factors, as the foot-and-mouth epidemic and its related effects will depress demand and output in the second quarter of 2001, with some recovery likely thereafter in the second half of the year," the bank said.
But these unusual disruptions aside, growth will remain around trend, it added.
The impact of foot-and-mouth disease will depress growth temporarily, it said, adding that the disease's effect on the medium-term outlook for inflation should be limited. The report also expects consumer spending to slow markedly in the coming quarters as households adjust to the weaker outlook for wealth and employment.
"The central projection is that consumer spending growth will ease a little below trend by the second half of this year and will then stabilise close to that level," it said.
Turning to wage pressures, the bank said settlements have risen only modestly but falls in headline inflation and inflationary expectations are likely to help offset upward pressure arising from the tight labour market.
Sterling's effective exchange rate has appreciated a little over the past three months with a rise against the euro more than outweighing its falls against the dollar, the bank said. Its projection assumes sterling's effective exchange rate index at 105.8. This index is expected to depreciate a little to 105.0 by the second quarter of 2003.