The Bank of England on Wednesday cut its forecast for economic growth and warned inflation is likely to slump in coming months, a downbeat assessment of Britain's recovery from its worst recession in decades.
Governor Mervyn King left the door wide open for the central bank's asset purchasing program to boost the money supply, saying that "it's far too soon to conclude that no more purchases will be needed."
The bank's Monetary Policy Committee froze its 200 billion pound ($310 billion) quantitative easing program earlier this month, but King said the committee "would keep its options open" as the British economy continued "to bump along the bottom."
"Further purchases will be made if it's necessary to keep inflation on track to meet the target in the medium term," King told reporters after the bank released its quarterly Inflation Report.
The report admitted that Britain's exit from recession at the end of last year was weaker than expected and forecast a very slow recovery, with output taking until around mid-2011 to return to pre-crisis levels. Gross domestic product growth was pegged at around 3.5 percent in two years' time.
The government has forecast growth this year of 1-1.5 percent and further growth of 3.5 percent in each of 2011 and 2012.
Britain officially ended a deep recession by recording a 0.1 percent rise in GDP in the fourth quarter of 2009. The weak growth rate supports the central bank's bleak assessment, although some upbeat data on industrial production, also released on Wednesday, suggests the early recovery might have been somewhat stronger.
The Office for National Statistics said the index of manufacturing was up 0.8 percent compared to the third quarter.
Jonathan Loynes, economist at Capital Economics, said that hinted that the fourth quarter GDP figure might be shifted upward in two planned revisions, calculated as more data is collated.
King said there were signs that "a gradual recovery in output may now be in prospect," but warned that the outlook was highly uncertain and appeared critical of positivity at a meeting of Group of Seven finance officials in Iqaluit, Canada, over the weekend.
"We all want to see a pick up and recovery in the world economy, but we are still in a difficult position ... I don't think we are out of the woods by any means," he said. "At the weekend, it was quite clear that among the G-7, several major economies were saying, 'We're relying on a recovery in the global economy to boost our demand.' Well, since, taken together, we were a large part of the global economy, it wasn't entirely comforting."
The report also predicted that inflation will spike to around 3.5 percent early this year, before falling back below the bank's 2 percent target in two years' time if interest rates rise as fast as markets predict.
Consumer price inflation shot up a full point in December to 2.9 percent, the biggest monthly rise on record.
But the bank said that inflation will quickly fall back as economic recovery is impeded by tight credit and the need to repair public and private balance sheets.
Assuming interest rates start to rise in the third quarter of this year, as forecast by many economists, the bank forecast inflation at around 1.2 percent at the start of 2012. It added that even if interest rates stayed at the current record low of 0.5 percent, inflation would still be below target.
King also stressed the need for Britain to get its fiscal house in order, as the country's budget deficit as a share of its gross domestic product remains on track to reach 12 percent this year.
Tackling the deficit has been complicated by a general election that must be held by the start of June, but King dismissed any comparison with the beleaguered Greek economy, where fears of a sovereign default have sent shockwaves through markets.
King noted that the maturity of government debt in Britain is much longer, making it easier to roll over.
"I don't think you can compare the U.K. with Greece," he said. "There are big differences. "We have our own currency. There is clear political consensus to take action to deal with the fiscal position here, there is a good track record."
He also played down the chances of Britain losing its gold-plated triple A sovereign rating.
"We're in a strong position," he said. "It's ours to lose, all we have to do is behave sensibly, and I'm sure we will."
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