By William Schomberg
LONDON (Reuters) - The Bank of England has received a short-term boost in its fight against inflation from Prime Minister Liz Truss's huge power bill bailout, but it still looks set to raise interest rates sharply later this month.
Truss's tariff cap - announced on Thursday and expected to cost 100 billion pounds ($116 billion) or more over two years - will allow inflation to peak as much as five percentage points lower than earlier forecasts, according to economists.
But at 11% - the new estimate of several analysts - the high point of inflation's recent surge would still be way above the BoE's 2% target, doing little to ease policymakers' concerns about inflation expectations getting entrenched in the economy.
GRAPHIC: UK inflation expectations https://fingfx.thomsonreuters.com/gfx/mkt/zjvqkrkwdvx/Two.PNG
The BOE's policy decision got pushed back to Sept. 22 from Sept. 15, due to the national mourning after the death of Queen Elizabeth, but economists said they did not expect the week-long delay to change the policy outlook.
A preliminary Reuters poll of 30 economists taken after Truss'ss price cap announcement Thursday showed most were predicting a 50 basis-point rate hike this month.
That would match last month's increase but would be only the second time since 1995 that the BoE has raised Bank Rate by that much. Bets in financial markets on an even bigger 75 basis-point hike have diminished sharply since Truss's announcement.
Further ahead, the scale of the support from Truss's power tariff cap and planned tax cuts are likely to create inflation pressures as households will be thousands of pounds better off than they would otherwise have been.
To counter that, the BoE could raise rates higher than previously anticipated.
"I suspect that the size of the package is probably going to weigh on the minds of Monetary Policy Committee members," George Buckley, an economist with Nomura, said.
He predicted a half-percentage point rate rise on Sept. 15 - with more hikes to follow.
BoE Chief Economist Huw Pill said this week the central bank would ensure government spending did not generate inflation.
James Smith at ING said the BoE might wait longer than other central banks before reversing its rate hikes in 2023.
"It probably means they're going to be looking at rate cuts much less urgently than the Fed or some of the other central banks which might be cutting rates by the middle of next year," Smith said.
RECESSION AVERTED?
Samuel Tombs, at consultancy Pantheon Macroeconomics, said the recession forecast by the BoE might be avoided narrowly, clearing the way for a half-percentage point rate hike next week and another in November.
That would take Bank Rate to 2.75%, its highest since 2008, where Tombs thought it would remain, a long way below bets in financial markets of more than 4%.
Philip Shaw at Investec said there was potential for the government with its stimulus push and the BoE with its rate hikes to end up pulling in different directions, raising the risk of policy confusion.
"The fact that the chancellor and the governor appear to be engaging in twice-weekly conversations is encouraging from the point of view of policy coordination," Shaw said.
New finance minister Kwasi Kwarteng and BoE Governor Andrew Bailey will meet regularly, initially twice a week, to coordinate economic support, the Treasury said on Wednesday.
Kwarteng is expected to announce an emergency budget, including tax cuts, later this month.
Also likely to push up BoE rates is the inflation-fuelling fall of the pound, which this week sank to its lowest level against the U.S. dollar since 1985, in part due to concerns about the scale of borrowing planned by Truss.
Other central banks are also raising rates aggressively to fight inflation. The European Central Bank increased its benchmark rate by 75 basis points this week, its biggest move ever.
GRAPHIC: The race to raise rates https://graphics.reuters.com/BRITAIN-BOE/lgvdwdlaapo/chart.png
As well raising rates, the BoE is about to start selling down the stockpile of British government bonds that it began racking up after the global financial crisis of 2007-08.
The MPC said last month it would hold a confirmatory vote in September on the start of the sales "subject to economic and market conditions being judged appropriate."
Some economists have suggested that the recent upheaval in the bond market might slow the BoE's sale plan.
($1 = 0.8630 pounds)