LONDON (Reuters) - Governor Mervyn King looks set to leave the door open to more support for the struggling economy when he presents the Bank of England’s new economic outlook on Wednesday, which is likely to show a tricky mix of lower growth and higher inflation ahead.
King faces a grilling over the Bank’s decision last week to halt the money printing press, as worries over high inflation trumped concerns about an economy which has slipped back into recession and faces new threats from the euro zone crisis.
With the government’s hands tied by its pledge to erase a huge budget deficit, and the economy well below its pre-crisis peak, King will also have to answer critics calling on the Bank to support firms and consumers more directly.
Most economists think the central bank will be reluctant to engage in another round of asset purchases with newly created money, known as quantitative easing, after buying a total of 325 billion pounds in gilts to support the economy.
But equally, most agree that King will avoid saying anything too definitive.
“They won’t want to rule out anything because they may well have to loosen (monetary policy) again,” said Scotiabank economist Alan Clarke. “The last thing the Bank wants is a jump in gilt yields that would undermine the loosening they’ve done.”
Gilt yields have fallen to fresh record lows despite the end to QE as investors concerned about the euro zone crisis have piled cash into British government bonds, a trend that has also driven the pound to 3-1/2 year highs against the euro.
The forecasts in the Inflation Report provide important guidance for future policy; an above-target inflation prediction in the two- to three-year horizon would indicate the need to tighten, while a clear undershoot would give room for stimulus.
The economy has not fully recovered from the 2008-2009 slump, but King said earlier this month that Britain seemed on course for a slow, steady recovery later this year, citing more upbeat business surveys and a recent rise in employment.
But since the financial crisis, the Bank has consistently overestimated growth and underestimated inflation.
“There can be little doubt that the Inflation Report for May will once again show the depressing mix of reduced GDP growth but raised consumer price inflation forecasts,” said IHS Global Insight economist Howard Archer.
In its February Inflation Report, the bank pencilled in a robust first quarter rebound after the economy contracted in late 2011 and predicted inflation would fall below its 2 percent target later this year and stay there for the next two years.
But the economy flatlined in the first quarter, falling well short of the Bank’s forecast of 1.1 percent annual growth, while inflation averaged 3.5 percent, above the 3.35 percent the bank had predicted.
In a Reuters poll, economists predicted that the central bank will cut its growth forecast to an annual 1.5 percent for the fourth quarter from 2.0 percent. The inflation forecast is seen above 2 percent in the fourth quarter, though dipping below the target in the second quarter of 2014.
Policymakers, most prominently Bank Deputy Governor Paul Tucker, have indicated that inflation may not fall below the Bank’s 2 percent target as soon as forecast. Inflation rose for the first time in six months in March, touching 3.5 percent, the highest rate among the Group of Seven major advanced economies.
Tucker also voiced doubts about official data showing that a steep slump in construction in the first quarter dragged overall output into the red, tipping the country back into recession.
The lack of growth has led to renewed calls for the central bank to buy assets other than gilts, such as company loans or mortgages, to make cheaper credit directly available to firms and consumers.
King has rejected such policies in the past, however, saying they would amount to subsidising specific sectors - a decision for the government, not the central bank.
Editing by Catherine Evans