The Bank of England appeared to rule out an early cut in interest rates to boost the flagging economy despite slashing its growth forecasts for this year to zero.
In its quarterly inflation report, the Bank admitted that it now expected the economy to grind to a halt in 2012 – compared to its prediction in May of 0.8 per cent growth.
But the Governor of the Bank of England suggested it was not considering cutting interest rates further from their current historic low of 0.5 per cent warning that the move could be “more counterproductive than beneficial”.
Announcing its revised forecasts Sir Mervyn King blamed the crisis in the eurozone, which he described as “a saga that goes on, and on, and on”, as the main cause of the slowdown.
But he also said the Government’s tough austerity measures had been a drag on growth. He added that the extra bank holiday in June for the Diamond Jubilee celebrations had reduced output by around 0.5 per cent.
“The underlying picture is that output has been at best broadly flat over the past two years, and has continually disappointed,” he said.
“The overall outlook for growth is weaker than in May reflecting downside news in the near term and, in the medium term, the possibility that the weakness in output and productivity growth that we have seen since the financial crisis persists.”
Sir Mervyn said early indications on the £80 billion “funding for lending” scheme to unclog the flow of credit were positive, with some banks cutting their loan rates.
But he warned: “The economy will continue to face headwinds over the forecast period, from the fiscal consolidation and tight credit conditions at home, as well as from the difficulties in the euro area and a broader slowing in the world economy.”
The weakness in euro area in particular was hitting demand for UK exports he said and efforts to rebalance the economy “will require patience”.
“As I have said many times, the recovery and rebalancing of our economy will be a long, slow process,” he added.
Some analysts had been expecting an early cut in interest rates to boost the economy
But Sir Mervyn said a rate cut was not a move the Bank would “contemplate immediately” as it would damage some financial institutions.
“We have not cut Bank Rate [from record low of 0.5pc] because it would be counter-productive and hurt building society sector,” he said.
In better news the Bank said the near-term outlook for inflation was lower than three months ago, reflecting weakness in price pressures and falling energy prices.
Oil prices are around 7 per cent lower in the run-up to the August report than in the run-up to the May report.
But Neil Prothero, senior economist at the Economist Intelligence Unit, said even the new forcasts of zero per cent growth was likely to be optimistic.
“The Bank of England’s growth forecasts are almost always overoptimistic, so subsequent downward revisions have become the norm for many years.
“Unfortunately for the UK economy, the Bank’s latest projections for economic output in 2012 of zero growth, and of average growth thereafter of around 2.5pc per year, while weaker than in the last Inflation Report in May, still almost certainly lie on the optimistic side.”