Economy 'still bumping along the bottom' says Mervyn King

Bank of England Governor Mervyn King said today that the ailing UK economy continued to "bump along the bottom", although he held out hopes for a "gradual recovery" in output.

His comments came as the Bank's latest inflation report admitted that the UK's crawl out of recession last year was weaker than hoped and lowered November forecasts for the pace of the recovery.

Today's report predicts that inflation will spike at around 3.5 per cent early this year - triggering another open letter to Chancellor Alistair Darling - before falling back below the Bank's 2 per cent target.

Mr King said there were "signs that many economies are on the mend", although "much uncertainty remains" about a sustained rise in global demand.

The pace of the UK recovery is predicted to be "somewhat less strong" than three months ago, with year-on-year growth likely to be around 3.5 per cent by the end of 2010 - rather than the 4 per cent forecast in November.

Huge help for the UK economy through £200 billion in quantitative easing (QE) and record low interest rates countered the headwinds of the "damaged banking system", he said.

He added that it was far too soon to conclude that no further asset purchases under the QE programme to boost the money supply would be needed.

The Bank's inflation forecast hinted at further measures to aid the economy and signalled that interest rates may be slower to rise than City commentators expect.

Although the Bank said inflation prospects remain "unusually uncertain", its forecasts show the consumer prices index slightly undershooting the 2 per cent target in two years' time even if rates are kept at 0.5 per cent and there is no unwinding of QE.

The report also outlined tough times ahead for consumers and the prospect of "significant fiscal contraction" in the years ahead, with households boosting savings amid fears of higher taxes.

The report also warned there was a risk that employment could fall significantly further if the recovery in demand is slower than companies expect.

Mr King denied the UK could soon face the turmoil currently confronted by the beleaguered Greek economy, where fears of a sovereign default have sent shockwaves through markets.

He said this was due to the broad political consensus over the need to tackle the UK deficit and the longer maturity of the country's debt.

"I don't think you can compare the UK with Greece - there are big differences," Mr King added.

He said the UK has a "very large structural deficit which needs to be eliminated", but also played down the chances of the country losing its gold-plated triple A rating.

Mr King said he "could not think of any reason" why the UK should be stripped of its premium rating if action was taken on repairing the public finances.

He added: "It's ours to lose - all we have to do is behave sensibly, and I'm sure we will."

When asked whether the UK could face one or more quarters of negative growth this year, Mr King said the forecasts accommodated the possibility of both falls and rises in the economy.

He said the "real debt problem in the UK was within the banking sector and the financial sector more generally" but institutions were making progress on their balance sheets.

He added that a weaker pound had taken "a bit longer than we thought a year ago" to pass through to export growth.