Britain's central bank said today that inflation would stay higher for longer and its governor cautioned that further bond-buying to boost the weak recovery might have limited impact.
The economy was set for a "slow but sustained recovery" over the next three years, and economic output was unlikely to surpass its pre-financial crisis peak until 2015, the Bank of England said in its quarterly inflation report.
"The UK economy is ... set for a recovery. That is not to say that the road ahead will be smooth," the bank's governor, Mervyn King, told reporters. "This hasn't been a normal recession, and it won't be a normal recovery."
The bank forecast that inflation in two years' time was likely to be around 2.3 per cent, up sharply from the 1.8 per cent forecast in November.
It also extended the time frame for inflation returning to target to early 2016, 18 months later than what it predicted in November. The bank's forecasts also suggest inflation will peak at about 3.2 per cent in the third quarter of 2013.
In a news conference following the release of the report, King - who is due to retire in June - 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.
The Bank of England has spent £375 billion (€433 billion) on buying government bonds but more recently has held off from increasing the programme.
Mr King said, however, that more purchases, or quantitative easing (QE), were no panacea.
"We must recognise ... that there are limits to what can be achieved via general monetary stimulus - in any form - on its own," Mr King said, adding that incentives to spend now reduced spending plans of households and businesses in the future.
British government debt prices extended losses after that comment by Mr King. Earlier, sterling fell to a six-month low against the dollar after King reiterated the position of the bank's policy-making committee that it was ready to provide more stimulus if needed.
In its report, the bank said much of the higher inflation was due to sterling's weakness and rises in prices partly set by the government, and that "it was appropriate to look through the temporary, albeit protracted, period of above-target inflation."
That comment suggested to some that the bank would be less likely to try to rein in inflation.
"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.
Howard Archer, chief UK economist at IHS Global Insight, suggested the bank was explicitly adopting a flexible inflation target "clearly favoured" by incoming Bank of England governor Mark Carney.
Mr 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 in bringing price growth back to its target level.
British inflation has exceeded the central bank's 2 per cent target since December 2009, and its persistent failure to return to target is one reason why the bank has not increased bond purchases past the £375 billion reached in October.
The Bank of England generally sets monetary policy with the aim of ensuring that inflation has returned to its 2 per cent target within two years.
Economists had expected the bank to revise up its inflation forecast, after a more than 3 per cent fall in sterling over the previous three months and the MPC's statement last Thursday that inflation might exceed 2 per cent for the next two years.
The growth outlook in the report was fractionally weaker than that given in November, with growth seen rising relatively steadily to average an annual rate of around 1.9 per cent by the first quarter of 2015.
Reuters
