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London: Britain's inflation rate rose in May to its highest since the Labour government came to power in 1997 but the Bank of England (BoE) played down the risk of early interest rate rises by saying the path for rates was still "uncertain".
The Office for National Statistics said yesterday consumer prices rose 0.6 per cent last month, taking the annual rate up to 3.3 per cent from 3.0 per cent in April - higher than forecasts for an inflation rate of 3.2 per cent.
The rise above three per cent meant BoE Governor Mervyn King had to write an open letter to the government explaining what the central bank would do to bring inflation back to its two per cent target.
The BoE revised up its short-term inflation forecast but said there were both upside and downside risks to the outlook and that the central bank faced a difficult balancing act between slower growth and rising prices.
"It's less hawkish than it could have been. Indeed, King even made some quite dovish comments and blamed most of the rise in inflation on global issues," said Paul Dales, economist at Capital Economics.
"Our sense is that this means interest rates are likely to stay on hold for now. The Bank does not seem to be in a rush to move in either direction," he said.
Futures
Short sterling futures climbed higher after the letter was published and sterling extended losses against the dollar as analysts interpreted it as reducing the chances of interest rates rises this year.
"[King] is accepting that the inflation profile in the near term is higher than that projected in the inflation report. But he's also stressing the longer term downside risk to inflation which is probably why short sterling is rallying so much," said Brian Hilliard, economist at Societe Generale. "Overall this is a relief for interest rate markets."
Under the BoE's remit, King has to write an open letter to the government if inflation deviates more than one percentage point away from the official two per cent target.
This has only happened once before - last April - since the BoE was given control of interest rates 11 years ago.
The BoE had expected the rise in consumer prices. It forecast last month that inflation could rise near to four per cent and in the letter said it could now rise above that rate.
Its policy direction is likely to be guided by the outlook for inflation over a two-year horizon, especially as a slowing economy is expected to tame price pressures.
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