THE Bank of England's Monetary Policy Committee's inflation report for May, completed ahead of the latest labour market data, shows a slight lowering in the central projection for inflation compared to the February report. Underlying inflation is likely to fall below its target of 2.5% by this autumn and remain there until well into 2000.

However, the assumptions do not reflect the fall in the exchange rate which has occurred, nor potential effects of the minimum wage. ''These factors, together with the strength of domestic demand and the future path of the exchange rate, will be crucially important to the prospects for interest rates,'' said the report.

Yesterday's labour statistics, showing acceleration in average earnings growth to 4.9% in the year to February against January's 4.6%, also cast a shadow over the report and add to the Bank's concern.

The private sector is running at 5.6% up from 5.2% at the time the report was written. Certainly prospects for any cut in rates look to have diminished and, in any event, the Bank gave no signal that it though rates might have peaked. A major concern for the Bank was the tightness of the labour market.

It stated that ''part of the improvement in the short run trade off between earnings and unemployment may be only

temporary.''

Mervyn King, the Deputy Governor elect, presenting the report yesterday, stressed that average earnings growth must slow if the Bank of England was to hit its inflation target of 2.5%. Pointing to the February growth rates, he said: ''To hit the inflation target those rates of earnings growth will have to fall back.''

Public sector earnings grew at an annual average of 2.6% in February, less than half the rate in the private sector.

''The gap between earnings growth in the public and private sectors is unusually large at present. It is not at all clear that

this gap is sustainable, King commented.

He added: ''Although the ratio of public to private sector earnings has been on a downward trend since the early 1980s, if the private sector measure is a better indicator of inflationary pressures in the labour market, then there would be cause for concern - and that is something that the committee will be monitoring very carefully.''

King also commented on the pound. He said: ''Now that it is clear that the board has been selected, the European Central Bank will actually be in existence in a few weeks time, that may lead to a resolution of some of the uncertainty and it is possible that that might weaken some of the support for sterling.''

However he went on to say: ''But far be it from me to ever forecast where the exchange rate will go.''

In making its revised inflation projections, the Bank points to a slowdown in the annual economic growth rate, which is now expected to fall below 2% this year, and the strength of sterling, a public perception of low

inflation.

However, the inflation forecasts could already be out of date given wages data and sterling's recent retreat.

The pound did perk up yesterday on the average earnings figures, but analysts expect this to be short lived.

HSBC's Adam Cole said that the Bank's inflation forecasts assumed sterling would fall to around its current level over two years and that they did not take account of the average earnings growth revealed in the latest labour market data.

''While neither of these developments is likely to be sufficient to bring interest rate increases back on the agenda, they underline our view that interest rates are likely to be slow to fall from here,'' he said.

Meanwhile, the minutes of the April monetary policy committee meeting confirm that there was a five-three split against raising rates. MPC member Charles Goodhart, formerly a ''hawk'' on rates, switched over to the doves.

At the MPC's previous two meetings, the eight-person team was split down the middle, with Governor of the Bank of England Eddie George using his casting vote to leave rates unchanged.

The May meeting also left base rates on hold at 7.25%. The minutes of this will be released next month.

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