Bank of England warns inflation will hit 10-year high of 4%

·Senior City Correspondent, Yahoo Finance UK
·3 min read

Watch: What is inflation and why is it important?

The Bank of England has radically raised its inflation forecast, warning that UK price rises could peak at 4% in the months ahead.

The Bank hiked its forecast for peak inflation in its latest Monetary Policy Report, which was published on Thursday. The report said price rises were set to hit a 10-year high of 4% in the final quarter of 2021, before falling back.

The forecast is bad news for savers, who will see the purchasing power of their cash piles diminish with interest rates stuck at rock-bottom levels.

The 4% inflation forecast is significantly higher than the Bank's May estimate of peak inflation at 2.5%. Inflation hit 2.5% in June, forcing a rethink at Threadneedle Street.

Read more: The chip shortage bringing car factories to a standstill

Despite rising inflation expectations, the Bank's Monetary Policy Committee (MPC) kept the UK's interest rate at a historic low of 0.1% on Thursday. Higher interest rates are typically used by central banks to rein in inflation by encouraging people to save rather than spend.

Rate setters stood pat because of a belief that inflation is only temporary and will fade over the next 12 months. 

"The Committee’s central expectation is that current elevated global and domestic cost pressures will prove transitory," the Bank wrote.

Andrew Bailey, governor of the Bank of England, giving evidence to the Treasury Select Committee earlier this year. Photo: House of Commons/PA via Getty
Andrew Bailey, governor of the Bank of England, giving evidence to the Treasury Select Committee earlier this year. Photo: House of Commons/PA via Getty

Higher prices are being driven by higher costs, amid a global shortage of goods such as semiconductors and a surge in demand for construction materials. Shipping costs have spiked, reflecting the boom in demand for raw materials and goods.

Read more: Why is the UK facing a HGV driver shortage and what could it mean for consumers?

The Bank of England said supply chain issues were likely to ease as more of the global economy reopened and trading conditions began to normalise. Demand was also likely to shift away from goods and towards services as the economy returns to normal.

Rebounding energy prices have also skewing inflation numbers. Oil futures well into negative territory last year but have since rebounded strongly, pushing petrol prices to an 8-year high. Fuel inflation is likely to ease in the coming months.

On the demand side, a reopening boom has given workers more power over wages as employers hunt for staff. Bank of England governor Andrew Bailey said the job market was a key "risk" to the committee's forecasts. If wages continue to rise, it could put more permanent pressure on inflation.

Read more: Bank of England holds policy unchanged as inflation debate heats up

But he added: "There are very good reasons to think that this will be resolved," pointing to the wind-down of the furlough scheme.

Bailey said the Bank of England was "not complacent" and would monitor the data closely. He said there was "no question" the central bank would act if there were signs of more persistent inflation.

"Its two-year ahead inflation forecast, 2.07%, only marginally exceeded the 2% target, while its three-year-ahead forecast of 1.88% was the lowest since Q4 2012," said Samuel Tombs, chief UK economist at Pantheon Macroeconomics.

"The Committee believes that a combination of well-anchored inflation expectations and medium-term fiscal tightening will ensure that CPI inflation falls back to and then slightly below the target, even if monetary policy remains historically very loose."

Watch: Why can't governments just print more money?

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