Euro area slump prompts BOE to cut growth forecasts

London

THE Bank of England (BOE) has cut its forecasts for growth and said inflation could fall below one per cent in months as a renewed slump in the euro area weighs on the UK economy.

In its Inflation Report published on Wednesday, policymakers led by BOE governor Mark Carney forecast expansion of 2.9 per cent in 2015 and 2.6 per cent in 2016 - down from 3.1 per cent and 2.8 per cent in August. They also said inflation will return to the 2 per cent target in three years, effectively validating investors' expectations that rate increases may not start for almost another year.

"The central path is a little weaker than in August, reflecting the weaker global outlook and a softer profile for private sector domestic demand," the BOE said. "The main downside risk stems from weaker euro-area activity, which would weigh on UK exports."

Investors have pushed back expectations for the first UK interest-rate increase to late 2015 amid downbeat assessments from BOE policymakers as well as the struggles in the euro area, where European Central Bank president Mario Draghi is pumping unprecedented stimulus into the economy to prevent deflation from taking hold.

The UK inflation rate has fallen below the BOE target and policymakers now see it continuing to decline in the short term. There is "significant probability" the rate of consumer price growth will fall temporarily below one per cent within six months, they said. Mr Carney would then have to write a letter of explanation to Chancellor of the Exchequer George Osborne.

The BOE also forecast weaker price growth than in August, cutting its 2014 projection to 1.2 per cent from 1.9 per cent, and its 2015 outlook to 1.4 per cent from 1.7 per cent. It kept its 2016 forecast at 1.8 per cent.

"There are significant risks on either side of this inflation projection," the BOE said, citing uncertainty surrounding geopolitical risks and the outlook for global commodity prices.

The BOE kept its estimate for slack in the economy at about one per cent. It also said the MPC (Monetary Policy Committee) has a "wide range" of views. Two members, Martin Weale and Ian McCafferty, have pushed for a quarter-point rate increase in recent months to guard against inflation pressures. Minutes of last week's decision, when the rate was left unchanged at a record-low 0.5 per cent, will be published on Nov 19.

While Mr Weale and Mr McCafferty have cited the importance of anticipating a pickup in pay growth, the BOE said cost pressure in the labour market remains subdued. Data on Wednesday showed that annual wage growth was at one per cent in the three months through September, up from 0.7 per cent.

While the BOE cut its modal GDP forecast, its mean projection was relatively unchanged, at 2.9 per cent and 2.6 per cent in 2015 and 2016.

The BOE cut its euro area forecast for 2015 to 1.25 per cent from 1.75 per cent. The potential impact of the weak eurozone economy can be seen in the BOE's detailed projections. They show exports falling one per cent this year, versus a previous expectation for a 2.25 per cent increase. Next year, overseas sales will rise 4 per cent, less than the 5.25 per cent previously anticipated. BLOOMBERG