LONDON (Reuters) - The Bank of England expects Britain's economy to enjoy its fastest growth since 2006 this year, helped by lower oil prices, but sees little need to raise interest rates soon and could even cut them if inflation proves weaker than expected.
Presenting an update on the BoE's view on Britain's economy, Governor Mark Carney said inflation would probably soon fall below zero due to the lowest oil prices in nearly six years.
But less than three months before an election he stressed Britain did not face the same damaging cycle of falling prices and spending that threatens the euro zone, and which prompted the European Central Bank to announce a trillion-euro bond-buying plan last month.
"The UK is not experiencing 'deflation'," Carney said in a letter to finance minister George Osborne which explained why British inflation had sunk to a 14-year low of 0.5 percent.
"The headlines today mask stronger underlying dynamics which will determine UK output and inflation tomorrow," he said in the letter, which accompanied a series of quarterly forecasts.
The BoE's new forecast that inflation will rebound to hit its 2 percent target in about two years' time, and then slightly overshoot it by early 2018, was the most aggressive such call by the Bank in five years, according to Citi.
Britain's economy began to grow strongly in mid-2013 after stagnating for much of the period since the financial crisis. But the plunge in oil is helping the BoE to keep interest rates at the record low 0.5 percent where they have been since 2009.
The Bank's upbeat outlook, including a pick-up in earnings, will be welcomed by Prime Minister David Cameron who hopes the recovery will earn him a second term after May 7's election.
Sterling rose to a seven-year high against the euro and British government bond prices fell after the report.
If global growth slowed, however, and Britain became at risk of a vicious cycle of falling prices, the BoE said it was ready to cut rates, following in the footsteps of other central banks.
This is a major break from its previous position that a rate cut below 0.5 percent would hurt banks and other lenders.
RBC economist Sam Hill said the stimulus reference hinted at differences among BoE rate-setters. "It could be that some members would have preferred less emphasis on the next move in rates being a hike than was actually delivered today by the governor."
Carney said that due to lower inflation and faster wage growth, real take-home pay was likely to grow at its fastest rate in a decade this year.
After years of falling real wages, voters may feel some of the benefit of the economic rebound before May's elections.
Economic growth this year is forecast to rise to a nine-year high of 2.9 percent from 2.6 percent in 2014, the BoE said, and to be stronger than previously forecast in 2016 and 2017.
Financial markets were recently pricing in a rise in BoE rates only well into next year, a factor behind the Bank's forecast on Thursday that inflation would overshoot its target. Markets are now pricing in a rate rise in around a year's time.
"The market understands in general what the MPC is trying to do," Carney said. "It's pretty clear ... that the most likely next move in monetary policy is an increase in interest rates."
Additional reporting by London Bureau; Editing by Catherine Evans