Bank could start quantitative easing next month

By Sumeet Desai and Fiona Shaikh

LONDON (Reuters) - The Bank of England will probably have to ease monetary policy further to get the economy growing again, and could start buying gilts as soon as next month to achieve that, Governor Mervyn King said on Wednesday.

New forecasts from the central bank showed inflation at just 0.5 percent in two years, well below the 2 percent target, even with interest rates already at a record low of 1.0 percent.

The economy, already in its first recession since the early 1990s, is expected to shrink rapidly over 2009, growing again only towards the end of the year.

"The projections imply that further easing in monetary policy may well be required. That is likely to include actions aimed at increasing the supply of money in order to stimulate nominal spending," King told a news conference.

He said such an unconventional measure -- known as quantitative easing and practised with mixed results in Japan in the early part of this decade -- would almost certainly involve buying UK government bonds, known as gilts.

That was enough to light a fire under the gilt market. The March gilt future made its biggest one-day gain on record, rising more than two full points.

The pound tumbled and short sterling interest rate futures rose as markets had expected a much more hawkish set of forecasts. Many analysts had thought that interest rates might have already hit bottom last week.

"The scale of the forecast downturn is breathtaking. And, the inflation forecast is so low for so long that it clearly signals further scope for monetary loosening," said Michael Saunders, economist at Citigroup. "The message that policy will need to be loosened further could not be clearer.