* BoE forecasts inflation above 2 pct target until Q1 2016
* "Slow but sustained recovery" seen for next three years
* King raises doubts about more monetary policy stimulus
* Bonds and sterling fall on outlook for inflation and QE
By David Milliken and Olesya Dmitracova
LONDON, Feb 13 Britain's economic recovery will
prove slow, high inflation will take longer to fall, and the
central bank can do little on its own to improve matters, Bank
of England governor Mervyn King said on Wednesday.
Presenting the central bank's quarterly forecasts, King gave
a gloomier outlook than just three months ago. Worsening
inflation in particular points to a further fall in Britons'
real wages, which have just hit their lowest since 2003.
"This hasn't been a normal recession, and it won't be a
normal recovery," King told reporters.
Britain's recovery from the financial crisis will continue
to be slower than most of its peers, and inflation is now likely
to remain above the bank's 2 percent target until 2016 - 18
months longer than expected in November, the forecasts showed.
Before the financial crisis, that would have been a signal
the central bank would soon raise interest rates, but the
governor made clear tighter policy was nowhere on its agenda.
King said high inflation was due to a weaker currency and
government-ordered price hikes, not overly-loose monetary
policy, and that the central bank should look through the effect
of those factors on prices.
This is an approach that is likely to continue to find
favour after King steps down in June and is succeeded by current
Bank of Canada Governor Mark Carney, who has also championed a
"flexible" approach to inflation targeting.
But it does not mean the central bank is about to add to the
375 billion pounds ($587 billion) of bonds it purchased between
March 2009 and October 2012. It currently holds just over a
third of conventional gilts.
King said this policy - also known as quantitative easing -
faces diminishing returns.
"There are limits to what can be achieved via general
monetary stimulus - in any form - on its own," he said. "In
terms of its impact on growth, further monetary stimulus of a
general kind is like running up an ever-steeper hill."
British government bonds fell sharply on King's comments and
the darker inflation outlook, pushing up yields on 10-year
paper, and thus likely borrowing costs, to a 10-month high of
more than 2.24 percent, .
"Inflation only reaches target three years out, but the
(central bank) is quite clear it will not be adjusting the
policy stance to bring it about quicker," said David Tinsley, an
economist at BNP Paribas.
According to the new forecasts, Britain is set for a "slow
but sustained recovery" over the next three years, with output
unlikely to surpass its pre-financial crisis peak until 2015.
Inflation is expected to peak at around 3.2 percent in the
third quarter of this year, and then fall slowly to reach 2.3
percent in two years' time, up sharply from the 1.8 percent
forecast in November.
But King said the bank would not risk undermining the slow
recovery of the British economy by turning the screws on policy
to bring inflation back into line.
"Attempting to bring inflation back to target sooner would
risk derailing the recovery and undershooting the target in the
medium term," he said.
While the bank expects Britain to avoid slipping into a
'triple dip' recession, growth will rise sluggishly to average
around 1.9 percent a year by the first quarter of 2015 -
marginally worse than forecast in November.
King said stronger growth would only be possible if
Britain's government - already implementing unpopular austerity
measures - showed greater appetite for structural reform.
Stronger overseas demand for British goods was also
necessary, he added.
Since the financial crisis, Bank of England inflation
reports have often brought upward revisions to inflation
forecasts and downward revisions to growth.
Inflation has not been below 2 percent since December 2009,
and the bank often disregards short-term shocks to prices.
Wednesday's report suggests it is taking an even longer-term
approach to getting inflation back down, and is prepared to look
through several years of higher university tuition fees and
government-controlled energy infrastructure charges.
This upset some in the financial markets, and sterling fell
along with government bond prices, sinking to a 15-month low on
a trade-weighted basis.
"Market confidence in the pound was already thin. The
governor's admission that the inflation target is to be quietly
ignored while the economy remains in intensive care has
stretched it even further," said Jason Conibear, trading
director at Cambridge Mercantile.
BNP Paribas economist David Tinsley said that in effect, the
policies Carney might bring were already being put into effect.
"At the end of the second year - the old barometer for
whether or not policy should change - the latest inflation
projection is well north of 2 percent. In many respects, this
seems to be front-running Mr Carney's approach to 'flexible
inflation targeting'," he said.
Carney last week suggested he would seek a swift review of
the UK central bank's remit to focus on inflation with an
emphasis on more flexibility over how fast to bring price growth
back to its target level.
Economists now see a 43 percent chance of a restart to
quantitative easing, according to a Reuters poll published on
Wednesday. In his current job running the Bank
of Canada, Carney has favoured giving extended guidance on how
long interest rates will stay low, something avoided in Britain.
A complementary policy which some BoE officials prefer is
the bank's Funding for Lending Scheme which aims to reduce
credit costs. The bank said that there was growing evidence that
the FLS was helping private sector credit conditions, though it
was too early to see an increase in net lending.