Traders have pushed back expectations of interest rates rising from a record low of 0.5% because inflation has come down sharply in recent months. A hike is not priced in until halfway through next year.
But there were risks that inflation could rebound sooner than thought, pushing rates up earlier than expected, one of the Bank’s nine rate-setters, Kristin Forbes, said in a speech published on Monday.
“If the risks that I’m focusing on to our last forecasts come through, I think there is a chance that inflation will pick up faster than people had been expecting in the medium term, which then would most likely merit an increase in interest rates sooner than people are currently expecting,” Forbes told the Wall Street Journal.
The Bank also released a speech on Monday that American economist Forbes had given last Thursday, where she made similar warnings.
She said inflation, currently at a record low of 0.5%, may overshoot the government-set target of 2.0% before the end of 2016. The Bank has a remit to set interest rates so that inflation can be brought back to target within a “reasonable time period”.
In her speech, Forbes listed what she sees as five keys risks around the Bank’s forecast for the economy, published in November: stronger global growth than anticipated by the Bank; oil prices staying lower for longer than forecast; how big an effect a stronger pound has on the economy; faster productivity growth; and whether the Bank has been too optimistic about labour supply.
Stronger global growth, and in particular stronger US growth, should support exports and demand in a number of economies, Forbes said. That, combined with a boost from lower oil prices, would mean inflation is higher than the Bank has been forecasting over the medium term and above the 2% target in 2017.
But it could overshoot even sooner. The stronger pound could make inflation fall further in the near term but then bounce back faster to take the rate above 2% by the end of 2016.
“Several of the scenarios would imply a faster rate of growth and higher rate of inflation in the medium term than currently expected. These scenarios, if they occur, would imply an earlier increase in interest rates than currently expected, especially in order to ensure that any subsequent interest rate increases are slow and gradual,” she said.
But Forbes added that there were risks in the other direction, particularly from low oil prices and their effect on the economy.
“On the other hand, some of these risks ... imply a substantially lower rate of inflation in the short term, so that even when inflation does start to pick up, it would begin from a very low level and take some time before reaching the 2% target. These two scenarios would imply that there is no urgency to start tightening monetary policy today.”
The Bank will publish its latest forecasts for growth and inflation in mid-February.
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