LONDON (Reuters) - The Bank of England slashed its outlook for British economic growth to zero for this year, as euro zone “storm clouds” cast a long shadow and scars from the world’s financial crisis appear deeper than previously thought.
Governor Mervyn King said there was no urgent need to print more money, and even less of a case to cut interest rates, but in a marked contrast to the past, he warned that the economy would grow at sub-par speed for at least the next three years.
King’s bleak message will do nothing for Britain’s increasingly strained coalition governing parties, which need an economic recovery well ahead of 2015 elections to justify an austerity plan to erase a record budget deficit which is attracting growing criticism.
“We are navigating rough waters, and storm clouds continue to roll in from the euro area,” King told a Wednesday news conference to present the central bank’s latest forecasts.
“Unlike the Olympians who have thrilled us over the past fortnight, our economy has not yet reached full fitness. But it is slowly healing,” he said.
Sterling strengthened and British government bonds underperformed German debt as markets had expected King to appear more open to further government bond purchases or to a cut to interest rates below their record low of 0.5 percent.
The BoE resumed its asset buying last month, launching a four-month, 50-billion-pound ($78 billion) program with newly created money to keep a lid on borrowing costs and pump more cash into the economy.
Since then, figures have shown Britain’s recession has deepened, with little sign of a hoped-for bounce in activity in July or a boost from the Olympic Games the country is hosting.
“If the Bank’s view on the economy comes to pass, the Chancellor (finance minister) faces a very rough road with the public finances as he tries to cut the deficit,” said Graeme Leach, chief economist at the Institute of Directors business lobby.
Many economists are still betting in another dose of quantitative easing asset purchases later this year.
“The Inflation Report clearly leaves the door wide open for the Bank of England to act again, we suspect that the MPC will wait until November before delivering another 50 billion pound dosage of QE,” said Howard Archer from IHS Global Insight.
Government spending cuts, the drag from Europe, bad weather and one-off factors including an extended break for Queen Elizabeth’s Diamond Jubilee celebrations have all weighed on demand.
Many market economists — as well as the Organisation for Economic Cooperation and Development — are now predicting the economy will shrink over 2012 as a whole.
The country has not recovered from the financial crisis that began in 2007, and many Britons are worse off as soaring prices and government tax hikes and spending cuts to slash a huge budget deficit have outpaced meager wage rises.
“We will get back to the same growth rates that we experienced before the crisis but it will take some time because again historical evidence suggests that when you get a major financial crisis, it does take a number of years to recover,” King said.
The lack of growth has piled pressure on the ruling coalition of Conservatives and Liberal Democrats at a time when gaping cracks have emerged between the two parties.
However, so far they remain broadly united on one thing - the need to cut Britain’s budget deficit.
“Of course you are going to get bumps in the road but the economy was always the overriding priority and that remains as strong today as it was in May 2010 - and that’s why we’re absolutely determined the coalition will carry on until 2015,” a source in Prime Minister David Cameron’s Downing Street office told Reuters.
But the temptation to exit the coalition will increase if their bet that growth will return to ease the burden of spending cuts sours further.
In the run-up to Wednesday’s quarterly inflation report, markets had speculated that King would allude more strongly to the possibility of future asset purchases.
Instead, he played down the possibility of immediate action, pointing to the BoE’s forecast that inflation was as likely to be above as below its 2 percent target in a couple of years.
“That in itself does not suggest an urgent need for further action,” he said.
King also restated his current opposition to a rate cut, which some economists had expected to ease since the BoE had discussed it in recent Monetary Policy Committee meetings.
“It (cutting interest rates) would damage some financial institutions and would therefore be counter-productive, which is precisely why we haven’t done it,” he said.
The central bank’s quarterly Inflation Report showed that growth was likely to be close to zero this year, rising to around 2 percent a year in two years time — down sharply from its forecast of 2.7 percent just three months ago.
“This is due to more weight being placed on the recent weakness of productivity growth as a guide to the medium term. But the causes of that weakness remain a puzzle,” said Malcolm Barr, an economist at J.P. Morgan.
August’s report marks a break with previous forecasts, which have shown strong rebounds in growth, even after short-term weakness, reflecting the risk that the factors contributing to the weakness of growth since the financial crisis may persist.
The BoE lowered its forecast for inflation for this year, but left its mid-term inflation forecast nearly unchanged at 1.7 percent in two years time.
Additional reporting by Sven Egenter, Guy Faulconbridge, Sophie Kirby, Venetia Rainey and Karolin Schaps, editing by Mike Peacock