Bank warning as growth forecast cut

Sir Mervyn King blamed concerns over indebtedness in the eurozone and disappointing growth and fiscal policy in the US for a sharp downturn in the market mood (EPA)

The UK's economy will not grow as quickly as previously expected and faces serious threats from the debt storms lashing the eurozone, the Bank of England warned today.

GDP is set to grow by around 1.4% in 2011, the Bank said in its quarterly inflation report, down from its estimate of around 1.8% in May.

It is the second time the Bank has downgraded the UK's growth forecasts this year, having previously expected growth of about 2%.

And next year's growth will also be significantly slower than previously thought at about 2% - down from around 2.5%, the Bank added.

The UK's growth is likely to be "sluggish" but will gradually grow to stronger than normal by 2014, it added.

But many economists said that even after today's downgrades, its forecasts were still too optimistic.

The UK's economy has failed to gather momentum as consumer spending is squeezed because wages are failing to keep pace with the rising cost of living. And its efforts to increase its exports have also been hamstrung by the slowdown in the world economy.

Bank Governor Sir Mervyn King said: "The outlook for growth in the world economy has deteriorated and, largely as a consequence, near-term growth prospects at home are somewhat weaker."

In addition, the debt crisis in the eurozone has the potential to impact significantly further on the UK economy.

Sir Mervyn added: "There are a number of headwinds to world and domestic growth over the forecast period, not least the private and public debt overhang. And these headwinds are becoming stronger by the day."

And he warned the global debt crisis, which has helped create turmoil in world stock markets in recent days, will take "a number of years" to be resolved.

He said: "The problems of indebtedness are large and not easy to tackle but we have to face up to it and find a way through it.

"2008 was not the end of the crisis, it was one stage of the crisis, and we are going through another stage now before, I hope, we come to an end of it."

The Bank warned that the near-term squeeze on consumer spending is set to continue and there is a "good chance" inflation will reach 5% in the coming months, driven by rising utility bills.

But inflation, which was running at 4.2% in June, will fall to 1.8% in two years, which is below its 2% target and slightly less than it expected three months ago.

The Federal Reserve yesterday pledged to keep US interest rates on hold for the next two years but Sir Mervyn refused to say how long UK interest rates would remain at their record lows.

He said the economy was too unpredictable to make such a statement but added that the Bank could raise rates or start another bout of money printing depending on the needs of the economy.

Economists are expecting interest rates to stay at 0.5% for a year or two.

Vicky Redwood, of Capital Economics, said: "Even after the latest downgrades, the MPC's growth forecasts still look optimistic to us, particularly in the light of the further market volatility seen since the committee signed off the report last week.

"Accordingly, we still think that keeping interest rates low won't be enough to generate a strong recovery and that more quantitative easing will be necessary."

PA