Chart 12 shows our current assessment of the inflation outlook, also assuming that Bank Rate rises in line with market yields, and with the most likely path lying inside the deepest red band. This shows inflation moving towards the target through next year, though, as I have already indicated, there is considerable uncertainty about the speed at which that will  4  For instance, the value added by the financial sector is conceptually very difficult to define and measure. The ONS are therefore forced to employ a variety of proxy indicators, such as balance sheet information. It is possible that these proxies overstated both the true contribution of the financial sector to GDP growth before the crisis and its subsequent fall. 4  BIS central bankers’ speeches  happen. But we judge the chances of inflation being above or below the target by the end of the forecast period to be roughly equal. In concluding, there are two general points that I want to make regarding the current conjuncture. The first is that the next few years are likely to continue to be rather difficult, especially for households and consumer-facing businesses. The economy is still adjusting to three substantial shocks, all of which conspire to reduce UK living standards. There is the loss in output associated with the banking crisis, the consequences of which households have hitherto been partially sheltered from by the expansion in the budget deficit.
It is worth noting that the current elevated inflation rate of 4.5% can be largely accounted for by the effects of energy and import prices and VAT: energy prices and VAT are probably each contributing around one percentage point to current inflation, and non-energy import prices around double that. The twelve-month inflation rate is likely to remain elevated through the remainder of this year, and indeed may rise further in the second half of the year, as utility prices are likely to rise sharply to reflect higher oil and wholesale gas prices. But inflation should fall back as we go into 2012 and factors such as the rise in VAT drop out of the calculation. But the pace and extent to which inflation will drop back will depend on a number of factors. First, there may be further significant movements in commodity prices and in import prices more generally. Second, there may be some resistance to the past erosion in living standards, resulting in a period of faster pay growth. Third, although pay growth has been subdued, the low rate of growth of productivity has nevertheless resulted in a squeeze in profit margins and there may be some attempt to restore these as the economy strengthens. Finally, if the period of elevated inflation leads business and households to expect higher inflation in the future, then it may also lead them to set higher pay and prices.