British inflation will fall to well below its 2% target in two years, even if interest rates remain at their record low, the Bank of England forecast today, leaving scope for further policy easing if the economy worsens.
The Bank of England noted that the prospects were 'highly uncertain' and it was ready to move policy in either direction, but the central bank's August inflation report is likely to reinforce analysts' expectations that interest rates will stay at a record low of 0.5% for some time to come.
In its August report the UK central bank sharply revised up its 2011 inflation forecasts, but said price growth would slow rapidly to around 1.4% the following year when a January 1, 2011 increase in value-added tax drops out of annual comparisons. This end-point was broadly similar to the two-year forecast in May's inflation report.
Growth is expected to be slower - seen at a rate of just over 3% in two years time - because of the extra fiscal tightening announced in the June budget, weaker business and consumer sentiment and credit conditions remaining tighter than the central bank had expected.
In May, the central bank had predicted growth of around 3.6% at its two year forecasting horizon.
The Bank of England left interest rates at a record low of 2% last week and maintained its 200 billion pound quantitative easing programme.
'The prospects for inflation were highly uncertain and the committee stood ready to respond in either direction as the balance of risks evolved,' the bank said about the decision.
The US Federal Reserve last night gave a sombre assessment of the economic outlook and set it would reinvest the proceeds from its mortgage-backed securities portfolio into US government bonds.
