Inflation report warns of impact from higher fuel bills

Inflation is expected to hit 5% later this year due to higher utility bills, the governor of the Bank of England, Mervyn King, has warned.

Publishing the Bank's latest Inflation Report, he said there remained strong downward pressures on economic growth and upward pressures on inflation.

However, he said that the "big picture" had not changed much since the last report in February.

The Bank still expects inflation to fall back in 2012 and 2013.

The Bank said the slightly gloomier outlook for economic growth reflected not just the dampening effects of high energy costs but also "very weak" consumer spending.

It downgraded its expectations for economic growth in 2011 to around 1.75%, from around 2% in February.

Mr King reiterated that the UK was facing "a difficult time ahead" and a "slow and prolonged adjustment to the consequences of the financial crisis".

'Uncertainty'

The governor said there was "a great deal of uncertainty about the outlook for inflation".

It meant that inflation "may not fall back as strong as expected", he said.

The Bank's latest Inflation Report has "pencilled in" an assumption that gas prices may rise by 15% and electricity prices by 10% this winter.

Several analysts have said they expect domestic fuel bills to rise this winter.

On Monday, Centrica, which owns British Gas, said domestic prices did not reflect what the company was paying on the wholesale market.

Higher food costs were also contributing to inflation's rise this year, the governor said.

Despite these "short-term" and "volatile" factors, Mr King said: "Our medium term judgement about inflation and growth is broadly the same as in February."

However, the Bank still expects such cost pressures to ease and for the rate of inflation - currently 4% - to begin falling to its 2% target next year.

He underlined that there were other factors pulling on inflation, especially low pay rises and weak economic activity. "Wage and money growth, at around 2%, continue to be weak," he said.

But this "softness" in economic activity was likely to be temporary, with a recovery in output likely to be driven by a continuing rise in business investment and a positive contribution from net exports", he said.

Rate debate

Following the Bank's latest forecast, some analysts deduced that an interest rate rise could come earlier than forecast.

"The Bank of England's Inflation Report suggests that in the Bank's view, the market has perhaps gone a little too far in not expecting an interest rate rise this year," said James Knightly, economist at ING.

"The market had been expecting the first rate hike to come in January next year, but following these details they are now anticipating it will be December and sterling has responded positively," he added.

Others took a different view, however.

"It does not alter our view that UK interest rates are set to remain at very low levels for a prolonged period and may well not rise at all until 2013 or beyond," said Jonathan Loynes, chief European economist at Capital Economics.

For his part, Mr King would not be drawn on the future path for interest rates, which have been at a record low level of 0.5% for more than two years.

"Bank rate will need to rise at some point. It cannot stay at this level indefinitely," Mr King told reporters.

"That doesn't tell you, I'm afraid, when Bank rate will rise," he added.