The Bank of England, in a surprise change of course, played down the chances of a further cut in interest rates Thursday, saying it expects the U.K.'s decision leave the European Union to weigh less heavily on the economy in the next year or so than previously thought.
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Officials also warned that there are limits to how far they will tolerate price-growth in excess of their 2% target, signaling that they may be prepared to raise borrowing costs if the pound's steep decline fuels a more rapid acceleration in inflation.
The central bank's change of stance underscores the uncertainty facing the U.K. as it heads towards Brexit, which is expected to take place in 2019.
Like many other forecasters, the BOE appears to have been wrong footed by the strength of the economy in the three months after the vote. But central-bank officials--as well as many economists--still harbor grave concerns over the possible toll an EU exit may have on the U.K. economy.
At its November policy meeting, officials on the BOE's nine-member Monetary Policy Committee voted unanimously to keep the BOE's benchmark interest rate at 0.25% and to press ahead with a GBP70 billion ($86 billion) program of asset purchases announced in August.
A fresh set of quarterly forecasts published by the central bank show that officials expect the economy to expand more strongly in 2016 and 2017 than they predicted in the summer, although they expect growth to tail off sharply in 2018 and 2019. They have penciled in growth of 2.2% this year and 1.4% in 2017, compared with earlier forecasts of 2% and 0.8% respectively.
They also expect higher inflation, a consequence of a battered pound. They now expect annual inflation to reach 2.7% by the end of next year, well in excess of their 2% target. Officials noted that sterling's slide accelerated further in October, after Prime Minister Theresa May signaled her willingness to sacrifice some economic closeness to the EU in favor of tighter control of immigration.
"There are limits to which above target inflation can be tolerated," minutes of officials' deliberations record.
They dropped guidance issued in August that another rate was likely this year, saying instead that "monetary policy can respond, in either direction, to changes in the economic outlook as they unfold."
The BOE's shift comes amid continued uncertainty over the U.K.'s future economic ties to the EU. Mrs. May has said she plans to give Brussels formal notice of the U.K.'s withdrawal from the EU before the end of March, a move that will start the clock ticking on at least two years of exit negotiations.
The shift also comes after Gov. Mark Carney ended fevered speculation about his future by saying Monday that he intends to stay in post an extra year, to mid-2019, to see the U.K. through the anticipated end of divorce talks.
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