Bank of England cautions on recovery

LONDON -- The Bank of England raised its forecasts for economic growth and inflation on Wednesday, but warned that Britain's economic recovery is just beginning and that its strength remains "highly uncertain."

The relatively upbeat report from the central bank, alongside improved unemployment figures also released Wednesday, provided some good news for Prime Minister Gordon Brown's embattled Labour Party ahead of next year's general election.

But some economists suggested that the Bank of England had overestimated the prospects for recovery and failed to factor in a likely tightening in fiscal policy after the election, which must be called by the start of June.

Bank Governor Mervyn King said the bank's moves to slash interest rates and pump billions of pounds into the economy, increased spending by the government and the depreciation of the British pound were likely to drive a recovery.

In its quarterly inflation report, the bank predicted that the economy will return to growth by the beginning of next year, and expand by about 3.75 percent by the end of 2011 - faster than it had forecast in August.

King said at a press conference after the report's release that he expects last month's data showing Britain was still officially in recession to be revised upwards.

The report also predicted inflation would rise sharply above the bank's 2 percent target in the short term, but that it would fall below target in two years time if interest rates rise gradually from the middle of next year as markets expect.

The central bank's report was released shortly after official figures showing that unemployment eased to 7.8 percent in the three months through September, down from 7.9 percent in the April-June period.

The Office for National Statistics said the rise in the number of unemployed people by 30,000 to 2.46 million was the smallest quarterly increase since March-May 2008.

In other positive news, the number of house purchase loans rose 2 percent in September from August, the third consecutive monthly increase, according to the Council of Mortgage Lenders.

"The Prime Minister has been feeling a bit more cheerful about the economy for a while, because there have been some good indicators around, and this is another indicator," Brown's spokesman Simon Lewis said of the jobs figures. "Of course, it is sad that unemployment is up even by a single number ... but the trend is looking more positive."

King did caution that Britain has "only just started on the road to recovery and the adjustment to balance sheets still has much further to run."

"Despite a recovery in economic growth, output is unlikely, at least for a considerable period, to return to a level consistent with a continuation of its pre-crisis period," he said.

But some economists said the forecasts were still too rosy.

"The bank's projections do not factor in the extra fiscal tightening likely after the next general election, making the central forecast of 4 percent GDP growth in early 2011 look implausible," said Hetal Mehta, senior economic adviser to the Ernst & Young ITEM Club economic consultancy.

James Hughes, chief economist at Black Swan Capital wealth management, said that the report "doesn't appear to consider with any degree of seriousness the potential impact on inflation of increasing energy and commodity prices via a weak sterling exchange rate."

The pound fell against the U.S. dollar after King's comments as markets factored in the likelihood that interest rates would remain low for many months. Sterling was down half a percent at $1.6664 midmorning.

The Bank of England slashed interest rates to the current record low of 0.5 percent and embarked on a 200 billion pound ($333 billion) asset purchasing program to boost the money supply after Britain entered its worst downturn in decades.

While other major economies like the United States, Japan and Germany have recently recorded a return to growth, Britain remains officially in recession, shrinking 0.4 percent in the third quarter.

Britain was hit particularly hard by the global credit crunch because of its huge financial sector, where the government was forced to carry out a multibillion pound bailout of major banks, and higher levels of personal debt among consumers. Like the US, it also faces a collapsed real estate bubble.

The Bank of England's forecasts are based on the assumption that the benchmark interest rate, currently at 0.5 percent, rises to meet market expectations of an average of 1.1 percent in the third quarter of 2010 and 2.1 percent in the first quarter of 2011.

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