UK ECONOMY:THE CONTINUING squeeze on UK household incomes will ensure "sluggish" growth in the near term, the Bank of England warned yesterday as it cut its central projection for gross domestic product growth for next year from 2.5 per cent to nearer 2 per cent.
In its quarterly inflation report, the central bank said there was “a good chance” that inflation would reach as high as 5 per cent this year, and that the timing and extent of the subsequent decline in inflation were highly uncertain.
Gilts futures soared after the report’s publication, in a sign that investors believe the bank’s rate-setting monetary policy committee will keep the bank rate at its record low of 0.5 per cent for longer.
Bank of England governor Sir Mervyn King was reluctant for the bank to follow the US Federal Reserve’s lead in making a conditional commitment to keep rates on hold until a set date.
However, he noted there was no obvious argument for the bank to do so, because markets were not pricing in a rate rise until early 2013.
The governor also signalled that the bank was unlikely to raise rates until the spread between banks’ lending rates and the bank rate – which is far wider than usual – narrowed. Any narrowing of the spread is likely to be delayed by banks’ need to deleverage.
Another round of quantitative easing was unlikely unless price pressures subsided to the point that inflation looked set to fall below target, he said.
The report said the “best collective judgment” of the members of the monetary policy committee was that following some near-term weakness, GDP growth was likely to pick up gradually, so that by 2014 it would be more likely to be above its historical average than below it.
However, Bank of England deputy governor Charlie Bean said there was now “less margin for rapid growth before inflation picks up” than before the crisis, implying that the bank believes the crisis has hit the UK economy’s potential output.
“The weaker growth outlook, the substantial downside risks and the sharper expected decline in inflation suggest that rates will be on hold for a lot longer,” said Jens Larsen, chief European economist at RBC Capital Markets.
Michael Saunders of Citigroup said: “The forecasts imply a long period of low interest rates, although the governor was reluctant to echo the Fed’s conditional commitment.”
In the medium term, inflation was “about as likely to be below as above target”, the report said. It said inflation had a good chance of reaching 5 per cent this year because of utility price rises and the continuing effect of the increases in VAT, oil and other import prices.
Inflation was likely to fall back during 2012 and into 2013 as those effects waned and downward pressure from slack in the labour market persisted. But this decline was likely to be mitigated by some upward pressure on wages in response to the sustained period of high inflation. – (Copyright The Financial Times Limited 2011)
