In its latest quarterly Inflation Report, released on Wednesday morning, the Bank of England seems to more clearly state, for the first time, that the financial crisis may have had some impact on the effective supply capacity of the economy.

Hence, at least in part, the subdued trends in productivity and the fact that, in the face of stubborn inflation, and despite subdued pay growth, weak productivity has meant no corresponding fall in domestic cost pressures.

Nevertheless, the MPC continues to judge that the UK economy is set for a sustained, albeit slow, recovery in both demand and effective supply, aided by a further easing in credit conditions.

Even so, the risks to economic activity remain weighted to the downside, not least because of the challenges facing the euro area.

In parallel inflation, as measured by the CPI, is likely to rise further in the near term and may remain above the 2% target for the next two years.

To that effect, the 'fan-chart' contained in said report now points to the risk of CPI reaching levels of even 5% toward the third quarter of the year, versus levels closer to below the 5% mark before. The probability assigned to higher than target inflation in the next few quarters has also risen notably.

But inflation is expected to fall back to around the target thereafter, as a gradual revival in productivity growth dampens increases in domestic costs and external price pressures fade, the Bank said.

In the November 2011 Inflation Report the monetary authority had argued that "Inflation in the near term is expected to be higher than thought likely in August, but further out the risks to inflation around the 2% target are judged to be broadly balanced."

Despite all of the above Governor King said that the Bank remains open to the possibility of further stimulus. He explained that while the MPC's remit is inflation stability in the medium-term, it is also charged with achieving this without creating undesirable volatility in output in the short-term, even if price stability is its primary goal.

Lastly, the medium-term forecasts for the level of gross domestic product (GDP) seem to have nudged slightly higher.

Commenting on today's data this is what Nomura had to say: "In its February Inflation Report, the Bank of England was surprisingly aggressive in revising its inflation forecasts up. They are now not too dissimilar to our own, which is worrying in as much as the systematic bias of the MPC in underestimating inflation might mean our hawkish assessment is not flying high enough. The Bank's growth forecasts remain much stronger than ours though, so it may just be that its systematic forecasting bias is being more exclusively focused on that side.

"But if the economy fails to recover - and we doubt momentum will last - the door remains open to further stimulus."


AB

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