Bank of England: Recession 'deeper than expected'

The recession has been deeper than expected and the timing and strength of a recovery is "highly uncertain", the Bank of England said today.

Its latest quarterly inflation forecast revised down the outlook for the economy, predicting a 4.5% year-on-year decline at its lowest point - considerably worse than Chancellor Alistair Darling's Budget forecast last month of 3.5%.

Inflation - currently at 2.9% - is also set to fall below the 2% target and "more likely than not" to remain below it in the medium term, the Bank added.

Bank of England Governor Mervyn King said "the economy will eventually heal, but the process may be slow".

The Bank said its predictions for the depth of the recession were weaker than its last report to reflect a worse than expected 1.9% decline in the economy during the first quarter of 2009.

It said the new forecast was also based on "a judgment that it is likely to take longer for bank lending to return to normal than assumed in February".

The Bank said the outlook for the UK economy "continues to be dominated by opposing forces".

It warned that the woes of the banking system and weakening global demand would continue to act as a "significant drag", although factors such as the pound's weakness, Government spending plans and the drastic action taken by the Bank on interest rates and boosting the money supply would "push in the opposite direction".

Mr King said it was likely "the supply of credit will continue to be restricted for some while", adding that banks remain risk-averse and focused on bolstering capital ratios.

The governor said there was great uncertainty about the outlook and judging the balance of the various factors in play on the UK economy was "extraordinarily difficult".

He added: "Some of the surveys afford promising signs that the pace in decline in activity has moderated. But they do not tell us how strong and persistent any such recovery will prove to be, precisely because of the uncertainty surrounding the way in which balance sheets will evolve."

The Bank also indicated that it could hold the cost of borrowing at a record low of 0.5% for longer than current market expectations.

Inflation forecasts based on expectations of an interest rate rise to 1% early next year - and the Bank's historic £125 billion quantitative easing programme to boost the money supply - showed the Consumer Prices Index further below the Bank's 2% target than with rates kept at the current all-time low.

The Bank surprised markets last week by increasing the size of its QE scheme by £50 billion, but said it would take time to assess the extent to which its purchases of Government and corporate bonds with newly created money had helped the economy.

Today's forecasts also suggested that the Bank could increase the scale of the programme again to hit the inflation target.

Chancellor Alistair Darling has approved up to £150 billion of spending under the QE scheme.

Jonathan Loynes, of Capital Economics, said the report injected a "sensible element of caution" amid recent talk about green shoots of recovery.

He added: "Although the Bank still predicts a reasonably solid recovery in GDP growth next year, it has pulled its forecasts down a bit from February and warned that a sustained recovery could take some time to arrive. This appears at least partly to reflect a gloomier view on the outlook for bank lending."

Howard Archer, chief European economist at IHS Global Insight, said the Bank had fuelled expectations of interest rates at 0.5% well into 2010.

He added: "We certainly suspect that, while latest data and survey evidence have been markedly improved and even hint that the economy could be close to stabilising, significant relapses remain highly likely and we could well be in for a very bumpy period for some considerable time to come.