Bank of England downgrades UK growth forecast

The Bank of England downgraded its growth forecast for the next three years on Wednesday but described the UK economy as solid and suggested interest rates would remain close to historic lows for the foreseeable future.

Predicting that inflation would remain close to zero before rising towards the end of this year to move back to its 2 per cent target, the central bank suggested interest rates were likely to rise for the first time in the middle of 2016.

George Osborne, chancellor, will be disappointed the BoE has downgraded its forecast, in response weaker expectations for productivity growth and investment, but the change brings the BoE outlook more into line with other forecasters.

Following relatively weak 0.3 per cent growth in the first quarter of 2015, the bank has reduced its central forecast for the full year to 2.6 per cent, from its 2.9 per cent estimate in February.

It has also revised its prediction for expansion in 2016 and 2017, cutting it by a similar amount to average 2.5 per cent - because of a more pessimistic outlook for growth in productivity (the amount of output per worker or hour worked) and labour supply.

"Productivity growth has been persistently weak since the start of the crisis and, despite the pickup in output growth, has remained subdued in recent years," the inflation report said.

Mark Carney, governor, said in the press conference that the Bank of England had limited tools to raise productivity growth. "Monetary policy . . . can only provide a foundation," he said.

"Mr Carney . . . made it clear that improving UK productivity cannot be solely the Bank of England's responsibility - effectively handing the problem to companies and politicians," said Lucy O'Carroll, Chief Economist at Aberdeen Asset Management.

The BoE, nevertheless, said that "the outlook for growth remains solid".

The bank does not publish forecasts for when it is likely to raise interest rates from their historic low of 0.5 per cent, but said its outlook implied, "only gradual rises in bank rate over the next few years".

Its inflation forecast, based on an assumption that interest rates begin to rise next summer and reach 1.4 per cent in spring 2018, showed the rate of price rises picking up and remaining close to the 2 per cent target over the next three years. It still expects the inflation rate is more likely than not to fall below zero in the months ahead.

"As the drag from domestic slack continues to fade, inflation is projected to return to target within two years and to move slightly above the target in the third year of the forecast period," the report said.

The bank was not seeking to push interest rate expectations higher. The report said that the "current market path [of interest rate expectations] remained consistent with absorbing slack and returning inflation to the target within two years".

In a letter to the chancellor explaining the reasons for inflation falling significantly below target, Mark Carney, bank governor, said that it had been "dragged down by falls in oil and commodity prices".

He added: "Inflation is likely to remain close to its current rate over the next few months, with a negative [rate] likely at some point over that period." But he said that inflation would rise later this year as the oil price fall last year dropped out of the annual comparison and that the BoE was aiming to bring inflation back to target in two years.

Mr Carney reiterated the BoE's mantra that if growth was stronger, interest rates would rise quicker than its central forecast, but if downside risks materialised, the bank could restart its quantitative easing programme or "cut bank rate further towards zero from its current level of 0.5 per cent".

(Additional reporting by Ferdinando Giugliano)

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