The Bank of England kept its key interest rate at a record low 0.5 per cent as expected on Thursday, judging that longer-term downward pressure on prices will quell an expected short-term spike in inflation.
Consumer price inflation was 3.3 per cent in November and is forecast to rise to four per cent in the coming months due to higher food and fuel costs and last week’s rise in the sales tax.
But the central bank forecasts that by early next year inflation will fall back to its two per cent target – which it has exceeded since December 2009 – as it does not expect the temporary rise in inflation to have a lasting effect.
Economists polled by Reuters last week were unanimous in the view that the Bank would keep its interest rates on hold and make no change to the £200bn of quantitative easing asset purchases conducted from March 2009 to February 2010.
However, financial markets are now pricing in a strong chance of an interest rate hike as early as May, as they predict the Bank will be forced to take action to defend its credibility in the face of rising public inflation expectations.