LONDON (AP) -- The Bank of England said Wednesday that it expects inflation to soar to 5 percent on the back of surging energy and food prices, and predicted a year of economic stagnation as Britain goes through a "difficult and painful adjustment" after the credit crisis.However, despite the projected spike in inflation far above the government's 2 percent target, the central bank opened a window for a cut in official interest rates as it noted that prices were likely to fall back significantly next year in reaction to the waning impact of energy, food and import prices.
If that happens, the bank would be free to reduce rates from the current 5 percent, encouraging spending to boost the economy, without the fear of spurring inflation yet higher.
"It is probably only the substantial near-term uncertainties over inflation, which make calculating the baseline for the longer-term forecasts difficult, that now stand in the way of the bank easing policy," said Hetal Mehta, senior economic adviser to the Ernst & Young Item Club. "Markets have reacted dramatically to today's report, fully pricing in a 25 basis point cut by early 2009."
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