Financial thoughts

The U.K. inflation rate probably rose to a seven-month high in January, limiting policy makers' scope to lower interest rates to counter the economic slowdown.

Consumer prices probably increased 2.3 percent from a year earlier, exceeding the Bank of England's 2 percent target for a fourth month, according to the median forecast of 36 economists in a Bloomberg News survey. The Office for National Statistics will release the data tomorrow in London, a day before the central bank publishes economic forecasts.

The bank cut the benchmark interest rate by a quarter point last week to 5.25 percent. It was the second reduction since the start of December to limit the fallout of the U.S. housing slump on the British economy. Policy makers are weighing that risk against the threat of consumer-prices getting out of control.

“The risk is that high inflation rates keep expectations high, making it more difficult for the Bank of England to bring the rate down to target,'' said Nick Kounis, an economist at Fortis Bank in London and former U.K. Treasury official. “We see, at most, two more rate cuts this year.''

The pound rose as much as 0.5 percent today on concern inflation pressures may limit the extent for further rate cuts, after a government report showed factories increased their prices at the fastest annual pace since 1991. The currency traded at $1.9504 as of 12:12 p.m. in London today.

Inflation Risk

The central bank said after its Feb. 7 rate decision there was a “risk that elevated inflation expectations keep inflation above target.'' Consumers forecast prices will rise 3.3 percent this year, the highest since at least 2005, a YouGov Plc survey last month showed.

Inflation may accelerate after oil prices reached $100 a barrel last month, and power providers raised energy costs for consumers. E.ON AG said Feb. 7 its U.K. unit would increase electricity prices by 9.7 percent and gas costs by 15 percent, making it the fifth of the country's six biggest energy retailers to charge customers more.

Manufacturers are also raising prices. Producer prices for goods including chemicals, textiles and food rose 1 percent in January on the month, the most since 1995, and 5.7 percent from a year earlier, the Office for National Statistics said in London today us fast cash. The cost of raw materials increased an annual 19.1 percent, the most since records began in 1986.

Bank of England Governor Mervyn King said Jan. 22 that policy makers face “a difficult balancing act'' as they gauge the risk that inflation may accelerate above 3 percent to match a decade-high. That would require him to write an open letter of explanation to Chancellor of the Exchequer Alistair Darling.

Pay Pressure

The bank is watching for price pressures in the labor market. Pay data released on Feb. 13 will probably show wages, excluding bonuses, rose an annual 3.7 percent in the fourth quarter, compared with 3.6 percent in the three months through November, the median of 20 economists' forecasts shows.

“The private sector won't be able to give in to wage increases that aren't justified by stronger production growth,'' said Peter Dixon, an economist at Commerzbank AG in London. “There are obvious inflation concerns, but the risk is to growth.''

Britain's economic expansion cooled to 0.5 percent in the three months through January, the slowest pace since 2005, the National Institute for Economic and Social Research said Feb. 8.

The Bank of England predicted in November that economic growth will weaken to about 2 percent this year from 3.1 percent in 2007. King will present new forecasts at a televised press conference on Feb. 13 in London.

“The Monetary Policy Committee is bound to cut their growth forecast'' in the inflation report, Michael Saunders, chief western European economist at Citigroup Inc., said in a research note. Still, policy makers will not “want to ease so fast that they stop the economy slowing in 2008 and produce a boom in 2009, because this would probably validate and extend the jump in inflation.''

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