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Economy faces choppy waters, says Mervyn King

The UK economy will “zig-zag” in and out of growth this year but is heading in the right direction, Bank of England Governor Sir Mervyn King said today.

In its latest quarterly inflation report, the Bank stuck by previous forecasts for low growth and falling inflation but predicted a less severe risk of recession in the first of half of this year.

But Sir Mervyn warned the economy faced “choppy waters” despite recent industry surveys painting a brighter picture and added there was “no easy remedy” to the consequences of the financial crisis.

The Bank appeared to endorse market assumptions that interest rates will be held at historic lows of 0.5% until 2014, a move which will please homeowners but anger savers.

Some economists warned the report was “too optimistic”, while others said the need for emergency measures – such as further quantitative easing (QE) – had faded.

In its central projection, the Bank forecast gross domestic product (GDP) of around 1% this year and 1.8% in 2013, while inflation will hit its 2% target in the final quarter of 2012 and fall to as low as 1.5% the following year.

Sir Mervyn said: “We can take some reassurance from the fact that inflation is now falling. But we are steering a course through choppy waters, and many people are experiencing difficult times.”

He said growth was likely to recover gradually, although “substantial headwinds” will hamper the recovery and there is likely to be a “zig zag” pattern of alternating positive and negative growth.

Sir Mervyn said the UK’s economy was moving in the right direction because it had a plan in place to tackle the country’s debt and it had devalued its currency without leading to a rise in wages.

David Kern, chief economist at the British Chambers of Commerce (BCC), said: “While we agree that growth will gradually strengthen from the middle of 2012 onwards, the pace of improvement is likely to prove slower than the report predicts.”

Sir Mervyn pressed the button on an additional £50 billion boost to the Bank’s QE programme last week but the report left analysts divided over whether further support would be forthcoming.

Alan Clarke, economist at Scotiabank, said last week’s cash injection is “likely to be the last” and added: “QE is an emergency measure and the emergency seems to have faded.”

However Vicky Redwood, economist at Capital Economics, expects inflation to fall further than the Bank has predicted and the economy will require additional stimulus.

She said the committee’s forecasts for growth “still look very optimistic” and added: “If growth is much weaker, as we expect, then QE is still likely to be extended further this year.”

The UK economy declined by an estimated 0.2% in the fourth quarter of 2011 and would return to recession with another contraction in the current quarter.

However, the Bank said monthly output indicators for January pointed to renewed GDP growth, with output growing modestly at the beginning of this year.

“But there is uncertainty about both the extent and persistence of that pick-up,” it added.

This uncertainty was highlighted by figures from the eurozone, which showed growth in the single-currency bloc declined by 0.3% in the final quarter of last year, including a 0.2% drop in the region’s powerhouse economy, Germany.

The Bank warned output is likely to be volatile this year, especially given the impact of one-off factors such as the additional bank holiday granted for the Queen’s Diamond Jubilee.

The report said growth is likely to remain weak before strengthening as household incomes recover, supported by low interest rates and QE.

However, the drag on spending from tight credit conditions and the Government’s tough austerity measures will persist, the Bank warned.

The Bank once again raised its concerns over the threat of the eurozone debt crisis, warning that reforms required to deal with those concerns would themselves weigh on growth.

The report said a failure to undertake the reforms could lead to “disorderly” outcome which would hit UK exports and the country’s financial sector.

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