Underlying inflation could exceed 3% by the end of 2002, according to Lombard Street Research's mont...
Underlying inflation could exceed 3% by the end of 2002, according to Lombard Street Research's monthly economic review. The economic think-tank's forecast contrasts to the majority view, including that of the Bank of England, which has inflation remaining below 2.5% for the next two years.
Martin McMahon, co-author of the report and an economist at Lombard Street Research, said there is a significant risk of a steep fall in sterling that could, in turn, lead to inflationary pressure.
McMahon also pointed to a number of domestically generated factors, further increasing the pressure on inflation.
Among these is the threat of higher petrol prices, as measured by the retail price index. Oil is now hovering between $24 and $25 a barrel, McMahon said, compared to $17 at the end of 2001. This has led to higher prices at the pumps.
If oil prices at the pumps remain at this level, he said, prices could be driven even higher. If the oil price remains stable at this level, however, it could still lead to a rise in inflation of 0.5%.
Similar factors that could exert upward pressure on inflation include Budget excise duty increases and large council tax hikes.
On a longer-term basis, McMahon said, an increase in the money supply will also lead to more inflation.
He added: 'At current rates, credit growth could run at double-digit rates in 2002. Increasing output could lead to supply-side bottlenecks, where there is an excess of actual output over potential output.'
Even excluding volatile elements like petrol and food prices, inflation has been on the rise. McMahon said low interest rates and pressure on the labour market from strong Government spending could lead to GDP growth that is higher than anticipated.
He believes inflation should remain close to its target until the middle of the year but could start rising strongly in the second and third quarters. He said inflation could breach 3% before the end of the year and is unlikely to fall back until the economy is slowed by rising interest rates.
The Bank of England's reputation could be damaged if it gets inflation targets badly wrong, according to McMahon. He said: 'The Bank of England's complacency over this inflation threat is unfortunate and will mar the otherwise good record in its first five years of operational independence.'
Professor Tim Congdon, at Lombard Street Research, predicted there will be no slowdown for current interest rates. A slowdown is in prospect only if the growth of domestic demand moderates, he said, but this is implausible as rates are at their lowest level for almost 40 years.
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