Economy set for triple whammy, admits Bank chief

Senior economist warns of deteriorating outlook<br/> Growth prospects hit hard by Osborne Budget<br/>Unemployment and inflation likely to soar

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The British economy faces a triple whammy of higher inflation, lower growth and rising unemployment, according to one of the Bank of England's most senior policy makers. Living standards over the next few years will rise only "minimally".

In an interview with The Independent, the Bank's chief economist, Spencer Dale, said that he did not expect inflation to return to its 2 per cent official target before the end of next year, about a year later than previously hoped, partly because of the hike in VAT to 20 per cent from January announced in the Budget.

And, although Mr Dale acknowledged that the emergency Budget had done much to avoid the risk of a UK sovereign debt crisis and a rise in interest rates, he also acknowledged that the Budget would mean lower growth. Mr Dale agreed that he would not be surprised if unemployment went higher in the next few months. For the next "three, four, five years, demand in the economy will be "incredibly anaemic" relative to previous recoveries.

Mr Dale said: "The near-term outlook for both growth and inflation has deteriorated over the past couple of months. Inflation has come out a little higher than expected, and the news on VAT in the June Budget means that the time it will take inflation to get back to target will be pushed out, and I expect it will be above target until the end of next year.

"Likewise, there are some signs that growth may be softening, again partly reflecting the June Budget. We've also seen tensions in the financial markets increase, related to concerns about sovereign debt issues in Europe. That has also affected the ability of banks and companies to raise cash.

"There's also the greater question of how things develop as countries around the world accelerate their fiscal consolidation plans."

The economy, said Mr Dale, would not return to normal "for an awfully long time".

The Office for Budget Responsibility has recently put the number of job losses in the public sector at around 600,000 over the next five years. Official data on economic growth in the second quarter of the year will be released by the Office for National Statistics tomorrow. While the pick-up in the economy is widely expected to have gathered pace, the European sovereign debt crisis in May and the June emergency Budget will have damaged business and consumer confidence, implying weaker growth and a possible "double dip" in future.

Meanwhile the European banking system faces a potential crisis tomorrow when the "stress tests" undertaken by European regulators on 91 leading institutions will be published. Banks that fail the tests – designed to determine their ability to withstand a financial shock – will have to be rescued or allowed to fail.

Over the next few years living standards, said Mr Dale, will be "less good than they would otherwise be" and will show only a "modest", "minimal" improvement. Tax hikes, muted pay rises, unemployment and public spending cuts will mean that things "won't feel good" for many families. Rising unemployment will also restrain house prices. The extent of the fall in public sector employment will depend on how public sector wage demands react to the pressure on budgets, said Mr Dale.

The Bank of England would remain wary of rising inflation even if there is evidence that the economy is weakening. Mr Dale condemns what he calls "dangerous talk" and complacency over rising prices: "I read a newspaper article the other day suggesting that a little more inflation might be a good idea because it would dissolve away mortgage debt. And a very senior executive said to me, 'aren't we going back to the bad old days when we just devalued and inflated our way out of trouble?'

"We know the evils of inflation. It adds to uncertainty, it destroys value of hard-earned cash and reduces the efficiency of the economy. We have to be incredibly vigilant."

Mr Dale is sometimes taken to rest on the "hawkish" end of the Bank's Monetary Policy Committee, broadly taking a more pessimistic view about inflation than some of his colleagues, and his latest remarks will add to the pressure, albeit nascent for now, on the Bank to nudge rates up more quickly.

If and when interest rates do start to rise they will add to pressure on homeowners, already suffering the tightest squeeze on household budgets since the Second World War. Mr Dale stressed the "huge" monetary stimulus the Bank was continuing to administer to the economy, with the bank rate at 0.5 per cent, a 300-year low, and the injection of £200bn directly into the economy via the Bank's "quantitative easing" programme. The impact of a lower bank rate, especially on those with tracker mortgages, has meant a substantial bonus in lower mortgage payments every month.

But Mr Dale added: "Since the spring of 2006 inflation has been above target for 41 out of 50 months and for two years it has averaged over 3 per cent. Now, we can come up with all sorts of clever and real reasons to explain our view but at some point people will say 'inflation just seems higher than it used to be' and that is a very substantial risk."