THE UK faces a “difficult time ahead”, Mervyn King, the governor of the Bank of England, has said as he disclosed lower forecasts for growth and higher forecasts for inflation.
Even with the weak outlook, however, the Bank signalled that there was likely to be a rate rise this year. Its forecast showed that inflation would remain higher than its 2 per cent target if it kept policy on hold.
Mr King stuck to tradition yesterday by refusing to predict when a rate rise was likely. He did say, however, that the analysis in the quarterly inflation report “does suggest that the Bank rate cannot stay at this [0.5 per cent] level indefinitely”.
“I don’t think it tells you which month it will rise,” he added.
Economists, however, interpreted the report as mildly hawkish compared with recent market expectations that the Bank’s monetary policy committee would refrain from tightening monetary policy until 2012.
Philip Rush, an economist at Nomura, said: “Clearly, the MPC is not trying to send a definitive signal of an intention to hike in August, but that appears to be its current approximate expectation, barring any major shocks.”
Of more lasting significance to the UK economy than the timing of the rate rises was the Bank’s revised view of its medium-term economic outlook.
Mr King warned British households that the period ahead would not be easy. “There is no doubt we are facing a difficult time ahead with a slow adjustment to the financial crisis,” he said.
Previously, the Bank’s central medium-term growth forecast was for the recovery to gather speed until growth averaged about 3.1 per cent, although the MPC had predicted it was more likely than not that the outcome would be worse.
Yesterday, it forecast that the recovery would build to an annual growth rate of 2.8 per cent.
This scaling-back of the central growth expectation implies that the Bank now expects the sustainable level of UK output to be 1.7 per cent lower in 2014 than it previously thought, but it does not expect this shortfall to moderate medium-term inflation. This more gloomy medium-term outlook was the result, Mr King said, of weakness in productivity, which the Bank now believed to be more persistent than it previously thought.
Mr King thought the recession and financial crisis had hit the level of sustainable output but said it was still too early to say by how much.
In the short term, the Bank is forecasting that inflation is likely to hit 5 per cent later this year as expected rises in gas and electricity bills add to oil, food price rises and tax increases, all of which have pushed inflation far above the Bank’s 2 per cent target.
The MPC has again become more pessimistic for the prospects of inflation falling quickly to its target, with the rate-setting committee thinking that only in summer 2013 will there arise a 50-50 chance of inflation falling below target. – (Copyright The Financial Times Limited 2011)
