Today's Bank of England Inflation Report contains a whiff of stagflation in its latest economic projections. Inflation is heading higher, at least in the short-run, while growth risks are to the downside:
In the central projection, higher energy and import prices push inflation above the target in the near term. Inflation then falls back to settle around the target in the medium term. The risks to growth are on the downside, while those to inflation are balanced.
The Bank expects tighter credit conditions and a slowing in domestic demand will slow UK growth to around 2% in 2008. While this is in line with private sector forecasts, I would not be surprised to see sub-trend growth dip towards 1.5% next year. Governor Mervyn King was ceretainly rather gloomy at today's press conference (webcast here). According to a Bloomberg report he warned that:
The central projection is for growth to slow sharply in the next year. ...There has been some tightening of credit. Residential and commercial property investment are likely to moderate, possibly quite sharply.
The Bank's latest forecasts are based on market assumptions that they will cut base rates by 25bp in the first quarter of next year. Indeed, financial markets are now expecting not just one 25bp cut around February 2008, but have also priced in a second cut around May 2008, which would bring official cash rates back to 5.25%.
New Chancellor Alistair Darling will certainly have his work cut out keeping budget and revenue projections on track. But at least British home owners can look forward to lower mortgage rates next year.