The UK economy is “static” as it faces cost-of-living pressures from higher energy costs and global tariff threats, said the Bank of England governor.
Rising petrol and water bills are forecast to see inflation lift to between 2.8% and 2.9% from its current 2.5% level when the Office for National Statistics publishes its January reading on Wednesday.
The central bank expects inflation to hit 3.7% in the third quarter of this year, before receding.
US President Donald Trump has vowed to impose tariffs on countries that charge VAT, leaving Britain at risk of a £24bn blow to its economy over two years.
The UK has a relatively high VAT rate of 20%, while US sales taxes are relatively low.
However, the UK received some unexpected good news last week, when official data showed the economy grew by 0.1% in the final three months of last year, driven by rises in the services and construction sectors. This followed no growth in the previous quarter.
But governor Andrew Bailey maintains a “gradual and careful” approach to further rate cuts, after the Bank’s rate-setting Monetary Policy Committee cut the base rate by 0.25% to 4.5% last week.
Bailey said: “We’ve had the gross domestic product numbers slightly stronger than we thought it would be, but I don’t think it changes the general story we have got, which is the economy has been quite static since late spring last year.
“The big question for us was to what extent is it demand and to what extent it is supply and demand, and that will go on being a big question for some time. Clearly, it matters as the more you think it is pure demand then that is going to bring inflation down faster.
“The more you think it is pure supply it will have the other effect, but actually a combination of the two is probably the reality.”
The central bank head was speaking in an interview with regional business news website BusinessLive on a visit to south Wales.
Bailey pointed to uncertainties around global trade after repeated threats by the US President against other countries to achieve American political or economic aims.
The governor added: “There is a lot of uncertainty around this and the news changes almost daily. If it leads to fragmenting the world economy that is bad for growth in the world economy.
“The impact on inflation is much more ambiguous. Do you get redirection of trade from the affected countries and what retaliatory measures are put in place and then what effect does it have on exchange rates? It is very ambiguous.”
Last week, Catherine Mann, who was one of two members of the nine-strong Monetary Policy Committee to vote for a higher 0.5% cut, said “bolder action” was needed by the body to support a fragile UK economy.
But Bank of England chief economist Huw Pill has said that caution was needed when cutting interest rates because the long process of wrestling down inflation “is not yet complete”.
The market expects between two and three further base rate cuts this year.
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