LONDON (MNI) – The Bank of England’s August Inflation Report is set
to show inflation, at least in the near term, higher and growth lower
than predicted back in May, while BOE Governor Mervyn King will leave
all policy options open at the press conference, analysts say.
The most powerful upward effect on inflation will come from the
plunge in market interest rate expectations since May, with another
upward effect from higher-than-expected utility price hikes. The
deterioration in the economic outlook will, however, see growth
forecasts cut.
The May Inflation Report’s central projection was based on an
implied market assumption that the first Bank Rate hike would come in
the third quarter of this year and that it would rise by some 25 basis
points a quarter in 2012.
In recent days, market pricing suggests no rate hike this year or
next. If the BOE’s August forecasts were to assume near flat rates, its
market based assumption would be near indistinguishable from its
constant rate projection.
In May, the Inflation Report’s market rate-based, modal projection
showed CPI peaking at 4.96% in third quarter of this year before falling
back below the 2.0% target, to 1.9%, two years ahead. The constant rate
assumption, however, showed CPI staying above target, coming in at 2.34%
two years ahead.
Using the May Inflation Report assumptions, taking away all the
implied rate hikes from the market rate based inflation projection would
add some 0.4 percentage point to CPI two years ahead.
In practice, the upward impact on inflation in the August
market rate assumptions will be less than this. The BOE bases its rate
assumptions on 15-working-day averages for SONIA and makes technical
adjustments to them, and the rate curve underpinning the report is still
likely to slope upwards.
The other big upward effect on inflation will come from the utility
price hikes, which have been even steeper than the BOE predicted in May.
In the May Report the BOE assumed a 15% rise in domestic gas prices
and a 10% rise in electricity prices during the second half of 2011 and
the first quarter of 2012.
Since then the utility companies have pre-announced price hikes in
excess of that. British Gas, the largest player in the retail gas
market, announced 18% and 16% rises to its gas and electricity prices,
coming into effect mid-August while Scottish and Southern Electricity
said it would up household gas tariffs by 18% and electricity by 11%
in mid-September.
Philip Rush, economist at Nomura, says the gas hikes will add some
0.3 percentage point, and electricity 0.2 percentage point, to CPI.
Offsetting the upward effects on inflation from lower rate
expectations and utilities will be a cut in the growth forecast.
The lower rate profile will, however, also help offset the
deterioration in the growth outlook with Rush saying it will add some
0.2 percentage point to growth. He expects the BOE to cut its 2012 GDP
growth by only 0.3 points on flat rates, so most of the impact will be
offset by the lower rate assumptions.
The Inflation Report will still, however, take “a more downbeat
view on growth” even though “ultimately it will end up with a higher
inflation profile,” Marchel Alexandrovich, economist at Jeffries, says.
Concerns over the deteriorating growth outlook are likely to
overshadow any increase in the inflation profile.
“The inflation story is not what the market will focus on,”
Alexandrovich says.
Press commentary ahead of the August Inflation Report has focused
on the near inevitable cut to the BOE’s growth forecast for this year.
The implied growth forecast in the May Inflation Report was for
1.9% (using the BOE’s “backcast”, or reworking of official growth
numbers) and there has been speculation the central bank could cut this
to 1.3%, bringing it back to consensus. The Treasury’s latest survey of
independent forecasters showed the average prediction was for 1.4%
growth this year.
In its May Inflation Report, the BOE’s implied forecast was for a
rapid rebound in growth in Q3, of 1% on the quarter, as activity
recovered from the impact of the prolonged Easter and Royal Wedding
break in Q2, but it may have trimmed this prediction, not least in light
of the worsening overseas outlook.
With some dramatic falls in some financial markets and mounting
concerns over the economic recovery, it is inevitable King will be
asked by reporters about the possibility of relaunching quantitative
easing.
Analysts expect King will simply refuse to pre-commit to any policy
path, and will leave all options open.
He will leave the door open to more quantitative easing and
“won’t want to send any clear signal that rates will go up any time
soon,” Alexandrovich says.
The Inflation Report will be published at 0930 GMT Wednesday but
the detailed, numerical projections that underpin will not be published
until a week later.
–London newsroom: 4420 7862 7491; email: ukeditorial@marketnews.com
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