Bank of England governor Mark Carney appeared to bring forward the prospect of a rise in interest rates today even as he said they could be cut further should low inflation persist.
Mr Carney said the Consumer Price Index (CPI) measure of inflation was “more likely than not” to turn negative in the spring.
But the pound rose as the governor said: “Unusual as that is, it arguably isn’t the main story. The headlines today mask stronger underlying dynamics which will determine UK output and inflation tomorrow.”
Mr Carney said the next move in monetary policy was still judged most likely to be a rise in interest rates.
The Bank’s quarterly Inflation Report nudged up expectations for CPI at the end of the coming three-year period, predicting that the factors currently pushing it lower would fade and lifting forecasts for wages and economic growth.
Sterling climbed to a seven-year high against the euro while it was also up by a cent against the US dollar as economists said Mr Carney had left the door open for an interest rate hike before the end of this year.
The forecast for inflation over the next few years contrasted with near-term predictions, suggesting CPI would average around zero in the second and third quarters of this year, before starting to climb before the end of 2015.
Mr Carney said the current period of low inflation - boosting spending power - was positive for the economy. Latest official figures showed it fell to 0.5 per cent in December, equalling an all-time low.
But he indicated that should it prove more persistent than currently expected and threaten a “self-reinforcing” spiral, the Bank’s Monetary Policy Committee (MPC) would need to provide “more support”.
This could include an expansion of its £375 billion money printing programme, known as quantitative easing, or a cut in interest rates further towards zero from the current rate of 0.5 per cent.
Mr Carney has previously only cited the possibility of a slower-than-expected rise in interest rates rather than a reduction from the current 0.5 per cent