* UK economy may shrink in final quarter of 2012-King
* BoE independence in tact despite payments to government -King
* Gilt purchases remain instrument to stimulate economy-King
LONDON, Nov 14 (Reuters) - Britain faces the “unappealing” mix of a weak recovery and high inflation, the Bank of England’s chief warned on Wednesday, adding that the Bank could still restart its bond buying programme to stimulate the economy.
Governor Mervyn King also batted back criticism of the decision to transfer back to the government the interest paid by the government on the bonds the BoE bought as part of its stimulus programme.
The move had raised questions about the Bank’s independence.
But it was the economy that was King’s main thrust as he presented the central bank’s latest inflation and growth forecasts.
“We face the rather unappealing combination of a subdued recovery with inflation remaining above target for a while,” King said.
Britain just emerged from recession with growth of 1 percent in the third quarter, but King warned that this was driven by one-off factors and the economy may well shrink again in the final quarter of the year.
The Inflation Report, meanwhile, showed that inflation was likely to be significantly higher over the next 18 months than expected in August, posing a barrier to further policy stimulus.
King said that the outlook for inflation was the main reason why the policymakers decided to stop the purchases of gilts in November.
He reiterated that there were limits to what monetary policy could do to boost an economy undergoing far-reaching adjustments after the financial crisis amid severe headwinds from the euro zone debt crisis.
“But the (Monetary Policy) Committee has not lost faith in asset purchases as a policy instrument, nor has it concluded that there will be no more purchases,” he said.
King stressed that the government’s decision to change the handling of the interest it paid on the 375 billion pounds worth of gilts the central bank has bought so far did not undermine the role of the rate-setting MPC.
“The reason why we don’t feel terribly concerned about this is that it doesn’t in any way effect our ability to set monetary conditions or control the total amount of asset purchases or sales or the timing of them,” he said.
“It would be wrong to try and create an issue about independence when there’s no substance to it,” he said.
He also rejected the notion that the move was a step towards ultimately monetising the government’s huge debt pile.
“Parliament can always decide to do what it wants, Parliament is supreme, but the Monetary Policy Committee certainly won’t do that and the Chancellor re-affirmed that the MPC is in total control of asset purchases and asset sales,” he said.