Bank forecasts leave scope for further easing

LONDON (Reuters) - The Bank of England left the door open on Wednesday for more monetary easing, cutting its forecast for UK economic growth and predicting that inflation would fall well below its 2 percent target in two years.

A day after the Federal Reserve downgraded its outlook for the United States, the Bank’s quarterly Inflation Report -- the first since a harsh government budget in June -- showed it too is worried about the durability of the recovery.

“Business and consumer sentiment have shown signs of softening, measures of financial fragility remain elevated and there is great uncertainty about the outlook for both the United States and our most important trading partner, the euro area,” Bank of England Governor Mervyn King told a news conference.

Ten-year gilt yields slid to a 16-month low below 3.12 percent and sterling hit a one-week low below $1.57 as investors bet the Bank could restart its asset-buying, or quantitative easing, programme which pumped its 200 billion pounds into the economy before being put on hold early this year.

The Bank said it stood ready to move policy in either direction and noted the outlook for inflation was “highly uncertain.”

Most analysts expect the QE programme to remain on hold and rates to stay at their record low of 0.5 percent for many more months to come. But few are certain.

“It may take a more obvious slowdown in the economy to prompt the majority of MPC members to vote for a further bout of quantitative easing. But that may well materialise,” said Jonathan Loynes at Capital Economics.

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“And if nothing else, there is further support here for our long-held view that interest rates are going nowhere for a long time.”


The Bank forecast CPI inflation would fall to around 1.4 percent in two years. But that was not before remaining well above the target all through next year, a big upward revision to the forecast it made in May.

King blamed this mostly on a rise in value-added tax due to come in at the start of next year but inflation -- currently at 3.2 percent -- has repeatedly surprised on the upside and has been above target for much of the last three years.

“That does not mean the Monetary Policy Committee has taken its eye off the inflation ball, nor has gone soft on inflation. We have not. Rather, it is the consequence of a series of one-off price shocks,” King said.

He said there was yet little sign that above-target inflation had boosted people’s expectations of further price rises but that the MPC would be watching this carefully.

Bank of England Governor Mervyn King leaves the British prime minister's offices at 10 Downing Street in central London August 4, 2010. REUTERS/Toby Melville

At least one MPC member, however, has been calling for interest rates to rise. Andrew Sentance voted to raise rates by a quarter-point in both June and July and probably this month as well though minutes of last week’s meeting are not out yet.

For now, Sentance appears to be in the minority and the bias appears towards further easing. The economy grew by 1.1 percent in the three months to June but output still remains well below the levels before the credit crisis.

That Q2 figure might also prove the high-water mark given chancellor George Osborne announced the harshest budget in a generation in June. Most government departments will have their budgets slashed by a quarter over the next four years, potentially putting hundreds of thousands out of work.

Taxes are set to go up too, putting a further dent in consumer spending power. Recent surveys show confidence already faltering and the housing market starting to come down again, particularly as credit is still no longer plentiful as it was before the crash.

“We think that if the MPC witnesses further deceleration in the pace of recovery it will be tempted to ease policy further, engaging in further quantitative easing and boosting its asset purchases,” said David Page, economist at Investec.

“And we suspect that if necessary such an easing could occur before November’s Inflation Report.”

Editing by Mike Peacock