Bank slashes growth forecasts and leaves door open for more rate cuts

The Bank of England left the way clear for further cuts in interest rates yesterday as it slashed its forecast for UK economic growth for this year and next.

The Bank, which unexpectedly cut interest rates last week, said it now forecast growth of 2.0 per cent – below the UK's long-run trend and the Government's optimistic forecast of 2.25 to 2.75 per cent growth. Its quarterly inflation report revealed there was a small risk – perhaps 5 per cent – of Britain plunging into recession.

The Bank said the downward revision was the main reason for its surprise rate cut, and denied it had been guilty of confusing the financial markets in the run-up to its decision.

In its quarterly inflation report, the Bank said it had cut its growth forecasts because of the worsening outlook for the world economy. Mervyn King, a deputy governor, said the UK's outlook for growth in 2001 and 2002 was "somewhat weaker" than anticipated at the time of its May report.

"This reflects a more pronounced slowdown of the world economy, a weaker investment outlook and an unwinding of unplanned stock building," he said. "The risks... are on the downside." These included an even steeper slowdown in the world economy, further falls in corporate profitability and investment, a sudden break in the labour market and a sharp fall in the pound. "Only one of these is categorically not a downside one," noted Ciaran Barr, chief UK economist at Deutsche Bank.

The Bank also showed it believed inflation would remain below the Government's target for another two years, having undershot already for 27 months. Economists in the City of London said that a downward revision had been inevitable after last week's rate cut.

Jonathan Loynes, chief UK economist at the consultancy Capital Economics, said: "This report provides just about the clearest indication possible that the MPC feels further falls in rates are probably necessary."

Mr King shed further light on last week's controversial rate cut, saying: "No one pretended that the decision was easy." He said the MPC had to balance risks of over-stimulating the domestic economy and failing to support wider economic growth. "Delaying an easing of policy risked deepening the downturn," he said.

He rejected accusations the Bank had misled the financial markets in the run-up to the cut.

"It was unfortunate we sprang a surprise but the committee was faced with a choice – to surprise people by cutting rates, or surprise them by publishing a forecast which indicated a further cut was likely," he said. "It decided to take the more straightforward course of making a modest reduction in rates to keep inflation on track."

But Mr King said analysts had "misinterpreted" comments in the minutes of the July meeting that rates were less likely to go down as meaning they were more likely to rise. He told a news conference: "I would caution you not to read into the minutes what [the committee] will do next time."

Mr King played down risks that Gordon Brown would fail to meet his spending plans because of the slowdown.

"It is much too early to conclude that because there's weaker outlook for activity that tax revenues will come in below expectations because projections are made on cautious assumption," he said.