Britain is on the brink of a contraction as the euro crisis weighs heavy, and inflation will fall well below target, Bank of England forecasts showed on Wednesday, leaving the door wide open for more stimulus to boost growth.
In its quarterly Inflation Report, the Bank indicated it may have to add to its £275bn asset purchase programme, as it predicted inflation would fall to 1.3 per cent in two years time. It expects inflation to fall below its two per cent target by the end of 2012.
Most economists reckon the central bank will add another £50bn of stimulus in February.
The Bank also sharply revised down its near-term growth forecasts, and now sees a strong chance that annual growth rates will be below one per cent throughout 2012.
"The prospects for the UK economy have worsened," the Bank said.
It said slowing global demand, concerns about the solvency of several euro area governments, increasing strains in banking and some sovereign funding markets would weigh heavily on growth in the near term.
It said with output was likely to be broadly flat in the final quarter of this year.
Moreover, even if euro zone policymakers come up with a plan to resolve the debt crisis, growth in Britain's largest trading partner was set to remain weak.
"A failure to meet these challenges would almost certainly have significant implications for the UK economy," it said, adding that there was no meaningful way to quantify the most extreme outcomes.
The Bank's forecasts showed that the economy would pick up towards the end of the two-year horizon, with growth seen at around 3.1 percent at the end of 2013.
The Bank said there remained a range of views on the Monetary Policy Committee about the likely strength of the recovery as well as the risks to inflation.
Inflation eased to 5 percent in October and King said in an explanatory letter to the government on Tuesday that he expected it to fall sharply in the next six months and return to around target by the end of 2012 as one-off effects from this year's VAT rise fall out of the data.
The Inflation Report reiterated that view.
In its August forecasts, the BoE had expected inflation to fall to just over 2 percent by the end of 2012 and to 1.7 percent by the end of 2013.
City A.M. Reporter