Inflation forecast to stay stubbornly high

INFLATION data out this week is likely to cause a further headache for the Bank of England’s Monetary Policy Committee (MPC) after data on Friday showed the public’s expectations of long-term inflation had shot up sharply.

The MPC has long argued it would look through what it sees as a temporary spike in inflation. But, on average, economists forecast that annual consumer price inflation will ease slightly to a still-high 3.4 per cent after hitting an 17-month high of 3.7 per cent last month. The retail prices index (RPI) is only expected to moderate slightly from its 19-year high of 5.3 per cent. Inflation has remained above the three per cent upper threshold for all of 2010.

The MPC has maintained that factors behind the spike, such as the depreciation in sterling and the VAT hike in January, were only temporary. But some economists are increasingly disbelieving. Barclays Capital’s Simon Hayes said: “Our expectation is that inflation will continue to surprise the MPC on the upside. If the government were to announce a rise in VAT in the emergency Budget, as many expect, these forecasts would rise further.”

More concerning is the Bank of England’s own quarterly survey of inflation expectations, which revealed on Friday that the public expects inflation to be 3.3 per cent this time next year compared with 2.5 per cent in the first quarter. This suggests that the Bank’s inflation-fighting credibility is starting to wane.

But with an aggressive emergency Budget scheduled for 22 June, the Bank will face a tough choice over the next few months between sticking to its inflation-fighting mandate and keeping policy loose to stave off a double-dip recession.