Bank of England: 'Economy will recover but progress will be slow'

Inflation will rise to just above 1 per cent in 2 years time, and the economy will shrink sharply in the coming months before recovering at a slower pace than previously thought, the Bank of England said.

In its quarterly Inflation Report today, the Bank said there were significant risks in both directions to its inflation forecast, which was based on market rates and its £125 billion asset purchase programme.

The Bank sees inflation troughing at around 0.5 per cent at the start of Q4 2009 before picking up to around 1.2 per cent in 2 years time, still well below its 2 per cent target.

GDP is seen troughing with an annual fall of around 4.5 per cent at the start of Q2, with growth then resuming in Q1 2010 before hitting a growth rate of around 2.5 per cent in 2 years time.

The GDP forecasts, which show a flatter trough and growth resuming slightly later than in February's report, suggest the central bank will need to keep monetary policy loose for some time.

That is likely to involve keeping interest rates lower for longer and perhaps increasing the size of its quantitative easing programme.

"The outlook for domestic activity and inflation continues to be dominated by the balance between opposing forces," the Bank said in its report.

Weak global demand, the adjustment of the UK economy and weak bank lending were being countered by considerable economic stimulus, weak sterling, past falls in commodity prices and actions to improve the availability of credit.

The BoE said the world economy remained in deep recession and trade fell precipitously but there were promising signs that the pace of decline both at home and abroad had begun to moderate.

It said the timing and strength of the recovery was highly uncertain but on balance the economic stimulus already in train pointed to "a relatively slow recovery".

"The projected distribution for GDP growth is weaker than in the February report, reflecting lower-than-expected activity in the first quarter of 2009 both at home and abroad and a judgement that it is likely to take longer for bank lending to return to normal than assumed in February."

The BoE said it would take time to assess the impact of its QE programme and it will be many months before the effect will show in GDP data.

"It will continue to be difficult to isolate the impact of the APF."