Bank of England downgrades UK growth forecast

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The Bank of England has trimmed its growth forecast for the U.K. economy and warned that inflation will remain above target for another year — assuming the country isn't knocked off course by turmoil in the eurozone.

In its quarterly Inflation Report released Wednesday, the Bank's Monetary Policy Committee reduced its growth forecast for this year from 1 percent just three months ago to 0.8 percent. It also abandoned a longstanding hope that consumer price inflation, now 3.5 percent, will fall back to the official 2 percent target by the end of the year.

Bank Governor Mervyn King says he now expects inflation to return to target in the second half of next year, and insisted the economy is broadly on course to recover despite sliding back into recession between October and March. The Bank still expects annual growth of 2.7 percent next year, compared to 3 percent in the February report.

"Given the Bank's overly rosy view on inflation in the past, many will see the 2013 growth outlook as too optimistic," said Chris Williamson, chief economist at financial data company Markit.

King said the bigger picture "is of a gradual recovery in output, and of subdued domestic cost pressures meaning that inflation is likely to fall back as external influences fade."

Unemployment figures published Wednesday support that view, he said.

Britain's unemployment rate dropped to 8.2 percent in the first quarter, down from 8.4 percent in the last three months of 2011. The latest figure beat the market consensus of 8.3 percent.

"The positive news on the headline unemployment rate probably overstates the extent of strengthening in the labor market," said Chris Crowe at Barclays Capital Research.

"Many firms appear to have preferred to reduce hours rather than lay off workers in recent years," Crowe said, adding that he still expected to peak at around 9 percent.

Other data highlighted the pressures on British families.

Regular pay rose by 1.6 percent compared to a year earlier, the statistics agency said. Total pay including bonuses was just 0.6 percent higher compared to a year earlier, the lowest rate since March-May of 2009.

The number of people working part-time rose 118,000 in the quarter to 9 million, including 1.4 million people working part-time because they could not find full-time employment. Both totals were the highest in 20 years.

Howard Archer, European economist at IHS Global Insight, said the Bank's Inflation Report gave no strong indication whether it was likely to inject further stimulus into the economy.

The program of asset purchases, known as quantitative easing, has been paused after pumping 325 billion pounds into the economy since March 2009.

"We suspect that the Bank of England would prefer not to do more QE, but is prepared to act if underlying economic activity fails to improve," Archer said.

King said persistently high inflation, which peaked at 5.2 percent in September, has been caused by higher than expected commodity and energy prices. That has squeezed real take-home pay, in turn hitting consumption growth.

Credit conditions, meanwhile, remain tight, he said. "The direct and indirect exposures of U.K. banks to the euro-area periphery have affected funding costs," King said.