Inflation will fall back sharply to below the 2 per cent target over the next year as the effect of lower domestic energy price inflation feeds through, says the Bank of England’s quarterly inflation report.
The UK’s rate of inflation fell to 2.8 per cent in April from 3.1 per cent in March after energy bills were cut. according to the latest figures from the Office of National Statistics.
The sharp drop in inflation will then be followed by an increase to around the 2 per cent target as the falls in domestic energy prices drop out of the 12 month rate, says the report.
When CPI inflation reached 3.1 per cent in March, 1.3 per cent higher than a year earlier, it prompted an letter on behalf of the monetary policy committee from the governor 0f the Bank of England to the Chancellor.
The report says half of this increase can be explained by higher domestic energy and food prices.
It says there is more uncertainty than usual over the outlook for inflation, which can be affected by stronger demand growth on companies’ prices, the evolution of inflation expectations, prospects for energy and import prices, and the degree of spare capacity in the economy.
The pattern of household spending was erratic through 2006 and that appears to have continued into early 2007, says the report. But smoothing through this volatility, underlying consumption growth has been near to its average over the past 20 years.
The report believes that household spending should be supported by a recovery in real take-home pay, helping to offset the increase in interest rates since last August.
Government spending has been a significant contributor to overall demand growth in recent years and that was maintained through 2006. According to the Budget spending plans, the public sector’s contribution to nominal demand growth is set to decline over the next few years. GDP increased by 0.7 per cent in the first quarter, in line with its average rate over the past decade, according to the ONS’s provisional estimate.