Inflation is set to rise above 4pc and stay there into the middle of next year, the Bank of England warned, as energy bills, shortages of key goods and rebounding demand force up the cost of living.
Major rises in gas and electricity prices next month and again in April mean households are braced for sustained pain.
It raises the prospect of more rapid interest rate increases next year as the UK braces for inflation running at more than twice the Bank’s 2pc target. Financial markets predict rates will rise from 0.1pc to 0.25pc as soon as February.
Policymakers are reluctant to act too quickly or strongly, however, as higher interest rates will have little effect on global problems but would risk undermining the recovery at home by raising the cost of borrowing.
Andrew Bailey, the Bank’s Governor, said inflation is likely to rise above 4pc in the closing months of this year and could stay at that level into the second quarter of 2022.
In his letter to the Chancellor to explain why inflation was so far above target, at 3.2pc last month, he blamed energy prices, global commodities, shortages of key products such as semiconductors, and the rebound from prices held down a year ago by initiatives such as Eat Out To Help Out which adds to the year-on-year bounce in prices.
“In the recent unprecedented circumstances, the economy has been subject to some of the largest shocks it has faced in centuries and economic activity has been exceptionally volatile,” Mr Bailey told Rishi Sunak.
In August the Monetary Policy Committee said it anticipated “some modest tightening of monetary policy” in the coming years.
“Some developments during the intervening period appear to have strengthened that case, although considerable uncertainties remain,” Mr Bailey said.
In part this depends on how wages respond to rising prices, and how much businesses choose to pass their rising costs on to consumers. Surveys of businesses indicate average pay rises of between 2pc and 3pc, above pre-Covid levels, while some workers in sectors suffering from labour shortages are getting raises of between 10pc and 40pc.
Officials said they will wait to see whether the 1.6m workers still on furlough keep their jobs when furlough ends next week, or become unemployed.
Sir Dave Ramsden, a deputy governor, joined Michael Saunders, an external member of the MPC, in voting to rein in quantitative easing early, to reduce the risk of inflation expectations rising too far. They were outvoted by the MPC’s other seven members.
It means the Bank is on track to complete its asset purchases by the end of the year, by which point it will have built up a stock of £875bn of government bonds and £20bn of corporate bonds.
All nine policymakers voted to keep interest rates on hold on 0.1pc.
Economists are bringing forward their predictions for a rate rise.
Allan Monks at JP Morgan said the announcement was “more hawkish than expected, and opens the door both to a February hike and two rate increases next year”.
Kallum Pickering at Berenberg Bank anticipates a first increase in August 2021: “As growth momentum is slowing heading into autumn and amid rising risks, the bank of England will probably err on the side of caution for a while yet and wait until mid-year before lifting rates for the first time – perhaps with some strong interim guidance that a sustained normalisation of policy is on the way.”
Business growth slowed this month, according to the purchasing managers’ index, an influential survey from IHS Markit.
It fell to 54.1, its lowest in seven months. Any score above 50 indicates activity is growing, so this shows an expansion which remains robust but is no longer booming.
The survey also revealed companies are raising prices at the fastest pace since the monthly survey began in 2006.
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