By David Milliken and Andy Bruce

LONDON (Reuters) -Bank of England Deputy Governor Clare Lombardelli said on Monday she was more worried about the risk that inflation comes in higher – not lower – than the central bank has forecast as she made the case for only gradual reductions in interest rates.

Lombardelli, making her first speech since joining the BoE in July, said recent downbeat business surveys suggested that inflation could cool while strong wage growth posed a threat in the opposite direction.

She said she thought those risks were balanced.

“But at this point I am more worried about the possible consequences if the upside materialised, as this could require a more costly monetary policy response,” Lombardelli told a conference organised by King’s Business School.

Sterling rose by around a tenth of a cent as Lombardelli spoke.

The BoE has lowered rates twice since August, taking it to 4.75% from a 16-year high of 5.25%, less than cuts by the European Central Bank and the U.S. Federal Reserve due mostly to concerns about inflation pressure in the UK jobs market.

Most of the Monetary Policy Committee’s members also support gradual cuts to interest rates and Lombardelli’s concerns about the risk of higher-than-expected inflation suggest she might be close in her views to BoE Chief Economist Huw Pill who this month warned that pay growth remained stuck at a high level.

By contrast, another deputy governor, Dave Ramsden, said last week that inflation could undershoot the BoE’s latest forecasts, potentially requiring faster cuts.

Financial markets expect around three BoE interest rate reductions between now and the end of next year, compared with around six for the ECB and four for the Fed.

Lombardelli said a scenario where wage growth eases to around 3.5%-4% and inflation stabilises at around 3% rather than the BoE’s 2% target would be more costly to address, if that became the “new normal” expectation for firms and consumers.

Some economists think Britain’s inflation rate could rise to 3% in early 2025 after coming in stronger than expected in October.

Preliminary purchasing manager index reports published last week suggested a slowing of Britain’s economy but Lombardelli said she did not take a strong signal from a single release of data.

The BoE would have to watch for the risk of a further deterioration, she said, adding later that weakness in the euro zone was likely to affect Britain’s economy.

“Given the lags in policy it would be important not to act late if the economy moved in this direction,” she said.

Swati Dhingra, who has stressed the downside risks to Britain’s economy more than any other MPC member, was due to speak at around 1030 GMT.

Lombardelli, who is in charge of reforming the BoE’s forecasting and analysis processes after a report from former Fed chair Ben Bernanke, said an overhaul was needed and there would be “nose to tail” changes.

The BoE was already making progress in modernising its technology and data processing, and had introduced scenarios into its forecasting. But she acknowledged that there was a long way to go, she said.

“This programme is going to take time to work through – years not months,” Lombardelli said.

(Writing by Andy Bruce and William Schomberg; Editing by Susan Fenton)

---