The rise in CPI inflation to 3.7% in December and 4.0% in January was in line with a suggested profile prepared after release of the November number, although there were small differences in the detail. The chart shows an updated forecast based on the following assumptions:

• Unprocessed food inflation rises further to a peak of 7% in March before moderating to 3.5% by year-end.

• Energy prices trend gradually higher, with a 2.5% rise over the next 12 months.

• "Core" inflation – excluding energy and unprocessed food – runs at 2.25-2.5% annualised, in line with an estimate of the trend leading into the recent VAT hike.

On this basis, the headline CPI rate is projected to reach 4.4% in February, returning to this level in September before subsiding to 2.5% in early 2012 as the VAT effect drops out.

The core assumption underlying this forecast is conservative: rising inflation expectations and eroding spare capacity could lead to a firmer core trend moving into 2012.

In his latest explanatory letter, Bank of England Governor Mervyn King states that "The MPC's central judgement, under the assumption that Bank Rate increases in line with market expectations, remains that, as the temporary effects of the factors listed above wane, inflation will fall back so that it is about as likely to be above the target as below it two to three years ahead."

Despite the "remains", this appears to represent a hawkish shift relative to the November Inflation Report, which judged that inflation was more likely to be below 2% (probability of 56%) at the two-year horizon on the basis of less aggressive market expectations than currently. If confirmed tomorrow, the implication is that the MPC is endorsing the market's view of three quarter-point rate hikes during the course of 2011.