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Strong sterling could mask UK price pressures - Bank of England's Forbes

The Bank of England is seen in the City of London August 7, 2013. REUTERS/Toby Melville

By William Schomberg

LONDON (Reuters) - The Bank of England must watch for signs that sterling's recent strength has masked underlying inflation pressures in Britain, one of the central bank's newest policymakers said on Wednesday.

Kristin Forbes said in her first speech since joining the BoE in July that the effects of stronger sterling on inflation were likely to peak at the end of this year, raising questions about the best monetary policy response by the BoE.

"It is becoming increasingly important to monitor trends in domestically generated inflation, and especially unit labour costs, so that monetary policy can be adjusted appropriately and also be allowed to work through the economy with its own set of lags," she said in the speech.

Economists have been keen to hear the views of Forbes as they gauge whether more members of the nine-strong Monetary Policy Committee are likely to join the two who have already voted for an interest rate hike.

Forbes said sterling appreciated by 14.5 percent against a basket of other currencies between March 2013 and July 2014, contributing to a slowing of consumer price growth in Britain.

She said sterling's current level did "not appear to be substantially out-of-line with where it has traditionally been" and most firms, especially in services, had told the BoE that it had not yet substantially affected trade volumes.

Forbes stressed, however, that she was not trying to give any hint about where the currency would or should go next.

The consumer price index eased to 1.5 percent in August, comfortably below the BoE's 2 percent target.

The lack of inflation pressure has helped the Bank to keep interest rates at a record low of 0.5 percent.

Forbes said in her speech there was a chance that the inflation outlook could be changing.

"Does (the current level of CPI) incorporate a substantial drag from the past appreciation of sterling? If so, inflation could increase quickly as the drag fades, suggesting tighter monetary policy could be appropriate," Forbes said.

"Or is any such drag currently small or likely to persist for an extended period? If so, inflationary pressures could remain muted, thereby providing more time before an adjustment of monetary policy is appropriate."

Forbes, a former economic adviser to U.S. President George W. Bush, said simulation results suggested British inflation is running about 0.8 percentage points below where it would have been if sterling had not appreciated from its level in early

2013.

The difference could rise to as much as 1 percentage point by the end of the year, she added.

The findings raised questions about the tendency of BoE policymakers to "look through" the impact of currency movements on inflation, and whether domestic inflationary pressures could cause prices to increase faster than expected, she said.

Seven different measures of domestically generated inflation, which are less exposed to the impact of currency fluctuations and included gauges of wage growth, suggested little evidence of a pickup in inflation, Forbes said.

But it remained to be seen if the rebound in sterling was having less of a dampening effect on prices than would normally occur, possibly due to the effects of globalisation, or if the domestic measures of inflation understated inflation risks.

"It is critically important to monitor measures of prospective inflation to determine the appropriate path of monetary policy," Forbes said.

In an interview to The Independent, Forbes raised concerns over how current the data was. "The one thing that has concerned me as I've gone through the data is that so much of the data is lagged. We just got data for the quarter ending in June, so that's showing a trend that started in April", she said.

And to MPC critics such as former member David Blanchflower, who believe the Bank is underestimating the slack in the UK jobs market, Forbes says: "I'm not sure I would go all the way as far as David has, but I think he has a good point".


(Reporting by Shivam Srivastava in Bangalore; Editing by Hugh Lawson and David Gregorio)