In its quarterly update on the outlook for the UK economy, the Bank predicts that tighter credit conditions, slowing investment and reduced consumer demand, could lead to a deeper and more persistent” slowdown than it expected in November.
Based on market expectations of interest rates, growth would slow sharply to well below 2 per cent before recovering gradually from the fourth quarter of 2008.
However, rising food, energy and import prices are likely to push inflation sharply above target in the short term, whatever the path of interest rates.
The Bank, which is mandated to keep consumer price inflation around 2 per cent in the medium term, believes that if interest rates were held at 5.25 per cent, inflation would fall below target in two years’ time.
But if the monetary policy committee cuts rates to 4.5 per cent by the end of the year, as markets expect, the Bank’s central projection shows inflation settling above target, after peaking this summer close to the 3 per cent threshold above which governor Mervyn King must write an open letter to the chancellor.
Economists interpreted the report as a clear signal that, while the Bank might decide one or two further rate cuts were necessary, the scope for policy easing was less than markets anticipated.