Bank of England forecasts 'choppy' economic recovery

The UK economy faces a "choppy recovery" over the next two years, the governor of the Bank of England, Mervyn King, has warned.

His comments came as the Bank lowered its economic growth forecast and said inflation would stay higher for longer than previously forecast.

The Bank now expects the economy to grow by less than 3% in 2011, down from its previous forecast of nearer 3.5%.

It added that a lack of bank lending would limit economic growth.

"It will take many years before bank balance sheets and fiscal positions return to anything like normal," said Mr King.

"In the meantime they will act as headwinds to the recovery."

Mr King also warned that following an "unprecedented" period the UK economy faced a difficult rebalancing "away from private and public consumption and towards net exports", and that this could also hit economic growth.

He added that there were some factors helping to keep the economy expanding, most notably the continuing economic stimulus measures and the fall in value of the pound.

And although he said government spending plans were one of the reasons that the Bank had cut its growth forecast, he stressed that the chancellor's cost-cutting plans also reduce the risk of a new crisis for the economy.

However, Mr King said it would be "several years" before the economy adjusts "back to anything we can call remotely normal".

The Bank of England's Quarterly Inflation Report forecasts a range of different outcomes for GDP growth, which it publishes in a graph, with the darker central projection considered the most likely.

The central projection in the latest graph shows that the Bank predicts growth somewhere between 2.5% and 3% next year, below its previous forecast, but above the Office for Budget Responsibility's current estimate of 2.3%.

Jobless drop

Hugh Pym, BBC chief economics correspondent, said the City considered that Mr King was being too confident about future economic growth.

"He is still quite optimistic for next year in the view of the City of London," said our correspondent.

The Bank's report came after the latest official unemployment data showed a further fall in the jobless total.

The number of people unemployed in the UK fell by 49,000 to 2.46 million in the three months to June, according to the Office for National Statistics, the biggest drop for three years.

The Bank said the main factor behind its prediction that inflation would remain higher than previously forecast was the government's decision to raise VAT to 20% from 17.5% at the start of next year.

The most recent official figures showed that Consumer Prices Index inflation stood at 3.2% in June, above the Bank's target rate of 2%.

Retail Prices Index inflation, which includes housing costs, was higher still, at 5%.

Mr King stressed that inflation was likely to fall back below the Bank's 2% target in 2012, as next year's VAT rise drops out of the calculation.

As a result, interest rates are likely to remain very low for some time to come.

Double-dip?

The Bank's warning that the UK faces a difficult economic recovery could increase fears of a double dip recession.

However, while Business Secretary Vince Cable spoke at the weekend about his concerns of the UK falling back into recession, the Bank's own projections say this remains highly unlikely.

Energy Secretary Chris Huhne also ruled out the likelihood of a double dip recession.

"The reality is that it's very unusual that there is a double-dip recession in economic history," he told BBC Radio 4's The World At One.

"And there are a lot of forces that are working to sustain the recovery.

"We've got good export growth. We've had a recent report on manufacturing. I'm delighted to say the government is really keen on manufacturing."

The Bank of England's report did little to improve investor sentiment, however, and the UK's main share index, the FTSE 100, extended early Wednesday losses caused by concerns about the state of the US economy.

In line with other major markets, rattled by worries about the worsening outlook for the world's biggest economy, the FTSE 100 index closed down 131.20 points, or 2.4%, at 5,245.21.