U.K. Inflation Seen Rising as Stagflation-Lite Endures: Economy

U.K. inflation forecasts for this year were raised by economists, highlighting the quandary Bank of England policy makers face as they balance sustaining a recovery with the need to foster price stability.

Consumer-price increases will average 2.7 percent this year, compared with 2.6 percent seen in February, according to the median forecast of 36 economists in a Bloomberg monthly survey published today. They raised their predictions for inflation in each of the next three quarters.

The change in view chimes with the Bank of England, which raised its inflation projections last month while saying that the recovery will probably stay muted. Such a prospect has added pressure on Chancellor of the Exchequer George Osborne to rethink the BOE remit as soon as next week to allow more flexibility in achieving price stability while promoting growth.

“Inflation is probably going to rise further and probably not peak for another four or five months, and at the same time the economy is going to continue stagnating and perhaps going into a triple dip,” said Vicky Redwood, an economist at Capital Economics Ltd. in London who formerly worked at the Bank of England. “What you may call ‘stagflation-lite’ is going to persist for a while.”

The economists surveyed predicted inflation will average 2.9 percent in the next two quarters before slowing to 2.5 percent in the final three months of the year. They previously forecast a rate of 2.8 percent in the second quarter, followed by 2.6 percent in the next three months and then 2.4 percent.

Inflation was at 2.7 percent in January, remaining above the BOE’s 2 percent target for a 38th month.

BOE Forecast

For the second half of 2013, the Bank of England’s inflation forecast is higher than that of economists. The central outlook presented by Governor Mervyn King last month was for 3.2 percent in the third quarter and 3.1 percent in the fourth, with the pound’s weakness and increases in energy and other administered costs cited as reasons.

The pound has fallen about 8 percent against the dollar in the past six months. It’s the second-worst performer after the yen this year among 10 developed-market currencies, according to Bloomberg Correlation-Weighted Indexes.

Economists in the Bloomberg survey also cut forecasts for economic growth in the next two quarters by 0.1 percentage point for each period. They predicted 0.2 percent growth in the second quarter and 0.3 percent in the following three months.

The euro area, currently in its second recession in four years, will return to growth in the next quarter, according to a separate survey. Still, GDP will fall 0.2 percent this year, before advancing 1.1 percent next year and 1.5 percent in 2014.

Price Volatility

The U.K. outlook of price volatility juxtaposed with weak growth has intensified scrutiny of the bank’s 2 percent inflation target before the annual delivery of Osborne’s instruction to policy makers in tandem with his budget.

With Bank of Canada Governor Mark Carney having started a debate on new tools before he replaces King on July 1, focus has switched to the chancellor to see if he’ll give policy makers more room for maneuver to stimulate growth.

A gauge of inflation expectations rose to a 4 1/2-year high today on speculation Osborne will use his budget next week to announce a new BOE remit that may place less emphasis on inflation targets. The U.K. 10-year break-even rate, which measures the yield difference between gilts and index-linked securities, was little changed at 3.36 percent as of 12:11 p.m. London time. It earlier touched 3.37 percent, the highest since September 2008.

MPC Split

“If you look at break-even spreads, they’ve widened sharply in the run-up to the budget, so I think the inflation market is very much expecting some kind of relaxation of the inflation target,” said Jamie Searle, a fixed-income strategist at Citigroup Inc. in London. Osborne will deliver his annual budget to parliament on March 20.

Even with the higher inflation outlook, King and two other policy makers voted to increase asset purchases in February, though they were defeated by a majority on the nine-member Monetary Policy Committee. Chief Economist Spencer Dale, who sided with the majority, may reveal clues on his own outlook in a speech in London tomorrow.

The MPC also held the target for bond purchases at 375 billion pounds ($560 billion) this month, and the minutes of that meeting will be released on March 20.

‘Uncomfortable Inflation’

“If the MPC want to loosen policy, they’ll have to do so against a backdrop of uncomfortable inflation,” said Redwood of Capital Economics. “As long as the MPC is still thinking it’s largely temporary factors that are pushing up inflation, and as long as wage growth is still very subdued, the weaker economy is still the greater concern.”

Separately today, the European Central Bank said the economy should gradually recover later this year, aided by its loose monetary policy. Contained inflation expectations allow monetary policy “to remain accommodative,” the ECB said in its monthly bulletin. “Later in 2013 economic activity should gradually recover, supported by a strengthening of global demand and our accommodative monetary policy stance.”

European stocks rose to a 4 1/2-year high before regional policy makers began a two-day summit in Brussels. European Union leaders indicated in a draft statement they may grant countries such as France, Spain and Portugal extra time to cut deficits. The Stoxx Europe 600 Index climbed 0.7 percent.

Elsewhere in Europe, the Norwegian krone weakened after the Norges Bank kept benchmark interest rates unchanged at a sixth consecutive meeting and signaled a potential rate reduction later this year. The Swiss National Bank repeated its pledge to defend its franc currency cap at 1.20 per euro.

A report today may show that 350,000 Americans filed initial claims for jobless benefits last week, compared with a six-week low of 340,000 in the previous period, according to a Bloomberg survey of economists. The Labor Department releases the data at 8:30 a.m. in Washington.

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