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Last Updated: Wednesday, 16 May 2007, 10:31 GMT 11:31 UK
Bank still sees inflation risks
Bank of England governor Mervyn King
Mervyn King is charged with keeping the economy on an even keel
The Bank of England has warned that inflation still remains a risk in the medium term, despite interest rate increases and a drop in energy costs.

In its three-monthly report, the Bank said that although energy prices were a big influence on inflation, changes in other prices would be more important.

UK interest rates, now at 5.5%, have risen several times as the Bank tries to tackle the risk of inflation.

But the report said the higher borrowing costs would not hurt growth.

"Overall, the risks to growth are judged to be balanced, while the risks to inflation are balanced in the near term but weighted to the upside in the medium term," the Bank said in its report.

'Crucial question'

The UK's latest inflation figures, released by the Office for National Statistics on Tuesday, showed that growth in the consumer prices index (CPI) slowed to 2.8% last month, compared with a rate of 3.1% in March.

The Retail Prices Index, an inflation measure often used in pay bargaining, fell to 4.5% in April from 4.8%.

"The crucial question for the Bank is where inflation is likely to be once energy prices have settled down," said Bank of England governor Mervyn King.

In its report, the Bank said that "the contribution of domestic energy price inflation is set to fall sharply over the rest of this year".

"But the overall path of CPI inflation depends on what happens to other prices," the Bank explained.

"That in turn depends on whether companies' pricing decisions are more responsive to cost pressures - which have moderated - or to their expectations of nominal demand - which appear robust," it added.

In its report, the Bank said that it forecast inflation at 2% in two years' time.

Rate rises

Analysts said that the Bank's view on inflation was little changed and probably would point to more interest rate increases in coming months.

"The Bank continues to see medium-term inflation risks tilted to the upside, which confirms that the tightening bias remains intact," explained David Brown of Bear Stearns.

"The window of opportunity for higher rates is over the next three months."


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