The Bank of England (BoE) lifted its forecasts for consumer prices over the next three years, but higher inflation was expected to come at the expense of lower growth as UK households feel the pinch.
In its Quarterly Inflation Report, Britain's central bank lifted its forecasts for consumer price inflation (CPI), expecting a peak of 2.8% in the fourth quarter this year, up from its previous forecast of 2.7%.
CPI above target
After reaching this peak, the Bank said it expected inflation to gradually return to its 2% target level over the next three years.
Official data showed CPI at 2.3% in March, and April's number – published next Tuesday – is expected to be the same. CPI rose above the target level in February – its first time above this mark since 2013.
Wage growth flat
Rising levels of employment have driven consumer spending during the past year, while a weaker pound has raised import prices, but the BoE said that wage growth was failing to match the rise in CPI.
This, it said, would result in slower economic growth over the next three years, and the Bank lowered its growth forecasts, saying it now expected annual gross domestic product growth of 1.9% by the end of the year - down from its previous estimate of 2%.
Annual growth in 2016 was 2%, down from 2.2% in 2015 and 3.1% in 2014.
"The slowdown is led by weakening consumer spending growth," the inflation report said.
It added that the growth outlook would continue to be clouded by the response of households to Britain's departure from the European Union.
Growth in the first quarter of 2017 was disappointing, and data published today showing industrial production figures for March added to the gloomy evidence of a weak first three months. Industrial production grew at a modest 1.4%, down from the previous month's 2.5%.
"The poor data dilute any hopes that markedly slower GDP growth of 0.3% quarter-on-quarter in the first quarter could be revised up," said Howard Archer at IHS Markit.
Richard Berry at Berry FX said: "Growth forecasts have been trimmed and the Bank expects inflation to continue creeping up – ensuring the Bank of England's monetary policy committee will remain impaled on the horns of a dilemma: to raise or not to raise interest rates."
Even though the BoE lifted its inflation outlook, its forecast for end of year CPI remained shy of estimates from the National Institute of Economic and Social Research (NIESR), published earlier in the week. NIESR economists said they expected inflation to peak at 3.4% in the fourth quarter.