Inflation is likely to slow towards the chancellor's two per cent target within the next 12 months but "substantial uncertainties" remain about its future progress, the Bank of England has said.
Publishing its quarterly inflation report this morning, the bank predicted that inflation, which has risen steadily throughout the second half of this year to its present rate of 2.4 per cent, would accelerate in the short-term before falling back around the two per cent target by the end of 2007.
High output growth was matched by growing consumer confidence, despite the latter's "volatile" nature, governor Mervyn King said.
He warned that supply side risks remained significant, with labour market conditions clouded by the influx of foreign workers from eastern Europe and doubts emerging about the "capacity utilisations" of businesses.
On the general state of Britain's economy the bank delivered a largely positive report. Its prediction of future GDP said that the rate would continue close to the average rate of growth during the last decade, matching the 0.7 per cent GDP growth which took place in the third quarter of this year.
It predicted, however, that a slight decline would occur if expected decreases to government spending materialise.
On interest rates, Mr King explained that the monetary police committee (MPC) had decided to raise the base rate to five per cent against "a background of firm growth and a limited margin of spare capacity".
He hinted heavily that a future rise could occur in the new year, concluding: "The committee remains ready to take whatever action might be necessary in future. And it will continue, as always, to take its decisions one month at a time".
Jonathan Said, of the Centre for Economics and Business Research (CEBR), welcomed the report, saying that it reflected a wider consensus about the state of the economy among UK economists.
"Despite yesterday's inflation data, which showed that consumer price inflation unexpectedly failed to rise, the bank is sticking to the projection it made in August that consumer price inflation will rise over the next few months, and then decline thereafter," he said.
"Our overall take is that although the economy is likely to slow next year, this will not be reflected in the data before the next inflation report is due. If wage inflation rises in the next couple of months, rates will probably rise early next year."