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Thursday, 16 November, 2000, 22:59 GMT
Where now for inflation?
The Bank of England
Bank of England: Difficult to interpret "disco dancing" economic data
For more than three years, the Bank of England has been dictating the fortunes of savers and borrowers when it sets interest rates. BBC economics reporter Dharshini David looks behind the scenes at the Bank's calculations.

With interest rates being held at 6% for the last nine months, economic forecasters have been poring over the Bank's latest report on the outlook for inflation, trying to gather clues on where rates are heading next.

Could the next move in interest rates really be down? - Or could there still be disappointment in store for mortgage holders?

The Bank of England's latest Quarterly Inflation report comes at a time when the UK is enjoying a bout of low inflation. The RPIX measure of inflation that the Bank focuses on, which excludes mortgage interest payments, is currently 2% - 0.5% below the government's target of 2.5%.

Moreover, it has been below target for more than a year and a half and recently fell to its lowest level since 1975 when inflation began being measured this way.

And financial markets are signalling for the first time that they believe interest rates could fall in the future.

Difficult comparison

UK inflation is not only low in historical terms, but also by international standards.

Inflation is not easy to compare across countries as it tends to be measured in different ways. But a measure, known as the Harmonized Index of Consumer Prices, or HICP, is calculated for most European countries.

This has tended to be lower than RPIX as it does not include items such as house prices, which have been rising in recent years.

At the moment, HICP inflation is just 1% in the UK - which puts it at the bottom of the European Union league table - a far cry from the case a few years ago, when the UK could have been termed the inflation blackspot of Europe.

Against such a benign backdrop, what does the Bank of England have to say about the future path of inflation?

Stronger pound

In its previous Inflation Report published in August, the interest rate panel forecast that inflation would move above the target during the next two years. In Wednesday's report, it predicted that it would be at or below the target over this period.

There are two key reasons for this.

First, the pound has been stronger than the Bank had predicted in the summer. This means that imported goods, both raw materials and finished goods, are cheaper.

And second, wage pressures in the economy are weaker than had been assumed. Given how low unemployment has been, wages might have been expected to rise sharply as employers struggled to recruit and retain staff.

The Bank now thinks that the economy may be able to cope in the long-term with the current level of unemployment without a surge in wages.

Inexact science

According to Mervyn King, deputy governor of the Bank: "The outlook for the UK economy remains one of strong growth with low inflation".

But as Bank officials are the first to admit, forecasting is far from an exact science, and the future path of inflation is littered with uncertainty.

In the near term, Mr King pointed out that the recent fuel crisis and floods could make the economy's performance difficult to read.

He stressed that "all data in the next few months might bear some resemblance to old fashioned disco dancing - sharp movements in unpredictable directions causing much excitement accompanied by a good deal of noise".

Further out, other issues have to be considered. The oil price, which hit a 10-year high in September, has been higher than the Bank previously predicted.

But while acknowledging that this could put upward pressure on prices, the Bank of England maintains that the outlook for inflation is tame.

Little net impact

Equally, it claims that the measures in last week's pre-Budget report will have little impact.

The Chancellor's package will inject at least 3bn into the economy next year. But Mr King stated that "this will have little net impact on growth or inflation".

Instead, the Bank of England expects that the main factors that could cause the economy to overheat are strong consumer spending - which has been the backbone of growth in recent years - or a sharp fall in the exchange rate.

But it argues that this is balanced by the risk that the global economy will slow.

Risks aside, the Bank believes that inflation is set to remain low.

And this has sparked speculation that the next move in interest rates, even if it is not imminent, will be down.

And that can only mean good news as far as homeowners are concerned.

For savers, who already receive only a modest return on their funds, it will be less welcome.

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14 Nov 00 | Business
UK inflation falls
09 Nov 00 | Business
Bank holds interest rates
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