Bank hints at new interest rate rises

The Bank of England today raised the prospect of further interest rate hikes as it increased its inflation forecasts.

Mervyn King, the Bank's governor, said there was a 50-50 chance that inflation would climb more than 1% over its 2% target.

Under its remit, the Bank has to write a letter of explanation to the chancellor, Gordon Brown, if inflation moves more than one percentage point either side of its target.

"It's odds on that we'll have to write a letter over the next two years, according to these projections," Mr King said. "I'd say it's well over a half, the chance that we'll have to write a letter at some point in the next two years. But in the next six months, call it 50%."

The Bank's monetary policy committee last week surprised most analysts by raising rates to 4.75%, a quarter-point increase and the first upward move for two years.

In its latest quarterly inflation report, released today, it said measures of both consumer and producer price inflation had picked up since its May report.

"The announcements of further increases in domestic gas and electricity prices, and further analysis of the likely impact of the increase in student tuition fees, have raised the central projection for inflation in the near term," today's report said.

"Those temporary effects are likely to push CPI inflation further above the 2% target for a while."

Annual inflation rose to 2.5% in June - its highest level since 1995 and equalled only once before, in September 2005. The Bank today said inflation would rise to 2.7% in the coming months.

When rates were raised last week, Bank officials said the move was necessary to keep inflation on track against a background of firm growth and limited spare capacity, with inflation likely to remain above target for some time.

The Bank remains concerned about the impact of higher energy prices on inflation, and is particularly worried that higher petrol prices and utility bills could lead to higher pay claims - what it calls "second-round effects".

"It is clearly premature to say that we can declare that there are no second round effects from the recent pick-up in inflation, because we would expect to see a further pick-up in the next few months," Mr King said.

However, he stressed that the Bank had not made a decision that it was "necessary to raise interest rates further", adding: "I think we will have to wait and see for what other changes may or may not be necessary."

However, analysts believed another rate rise was on the cards given the Bank's higher inflation projections.

"There is clearly a very real possibility that interest rates could rise further before the end of the year," Howard Archer, of the consultancy Global Insight, said.

"This is particularly possible if growth holds up well in the third quarter and there are growing signs that high energy prices are feeding through to have increasing second round inflationary effects such as pushing up wages. However, we still lean towards the view that the Bank will not act again until 2007."

The Bank said risks to its inflation forecast were broadly balanced, but that the uncertainty was much greater than usual.

"There remains great uncertainty about future energy prices, especially in the light of political tensions in the Middle East, and inflation is likely to be volatile in the coming months," Mr King added.