Shock news! The Bank discovers optimism

The Bank of England's latest report forecasts inflation close to target and robust growth by the end of this year. Ben Chu examines the numbers

Sir Mervyn King yesterday signalled that the Bank of England's quantitative easing programme could be coming to end sooner than many financial analysts expected. The central bank's quarterly Inflation Report forecast that inflation will rise to 1.8 per cent by 2014, up from the 1.3 per cent prediction it made last November.

The CPI inflation rate is 3.6 per cent at the moment, but the Bank's Monetary Policy Committee expects inflation to fall drastically over this year, creating a medium-term risk of the central bank undershooting its target. Earlier this month the Bank of England's Monetary Policy Committee increased its asset purchase scheme by £50bn to £325bn. Yesterday's higher inflation forecast indicates that the MPC believes that that additional monetary easing will be sufficient to bring inflation back to target.

"The Inflation Report was on the hawkish side of expectations," said Alan Clarke of Scotia Capital. "Although, as ever, the Bank kept its options open, the level of the two-year-ahead inflation projection means that it is more likely than not that this latest phase of quantitative easing will be the last."

Some private sector analysts had predicted that the total QE programme would reach as much as £600bn.

Sir Mervyn also unveiled an upbeat message on UK growth. "With falling inflation and the prospect of an end to the squeeze in real incomes leading to a recovery in growth, we are moving in the right direction," he said.

The Governor admitted that there is likely to be a "zig-zag" pattern of alternating positive and negative growth rates over the coming months, but the Inflation Report forecasts the UK economy to be growing at a rate of more than 2 per cent by the end of this year.

Some analysts disagreed. The chief economist at the British Chambers of Commerce, David Kern, said: "While we agree that growth will gradually strengthen from the middle of 2012 onwards, the pace of improvement is likely to prove slower than the report predicts."

The Governor did, however, concede that the Bank's forecasts did not factor in the possibility of a potentially disastrous escalation of the eurozone financial crisis.

Sir Mervyn reiterated his view that small firms were suffering as a result of a credit squeeze imposed by private banks. But he said that it would be inappropriate for the Bank to buy up small business loans as part of its asset purchase scheme in order to ease the flow of credit to such firms – something that has been urged by the MPC member Adam Posen. "The first principle is that you need to use the banking system," said Sir Mervyn.

The Treasury is preparing a £20bn national loan guarantee scheme to be unveiled in the March Budget. But Sir Mervyn warned that the details of such a scheme would need to be carefully constructed to prevent the banks "dumping" bad loans on the Treasury. He said: "If the Government feels there is a particular problem with small businesses then the answer is a special scheme for small businesses, but the principle needs to be... to use the infrastructure of the banking system [and to] share the risks between the banks and elsewhere so the banks don't try to dump the worst risks on the public sector."

Sir Mervyn expressed his sympathy for savers, who are receiving negligible returns as inflation, for now, continues to outstrip interest rates. But he said that it would be counterproductive for the Bank to increase interest rates to help as this would simply damage the fragile economy. "These are consequences of the painful adjustment prompted by the financial crisis and the need to rebalance our economy," he said.

The forecasts in numbers

2 per cent The rate at which the Bank's latest Inflation Report forecasts the UK economy to be growing by the end of 2012.

1.8 per cent The Bank's estimated inflation rate in 2014 – up from 1.3 per cent last November and closerto the official target of2 per cent.

£325bn The scale of the Bank of England's asset purchase scheme, which might now not be extended.

0.5 per cent The Bank of England's benchmark interest rate, which is unlikely to be raised before 2014.

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