The Bank of England paved the way for another cash boost to shore up struggling Britain on Wednesday, slashing its growth and inflation forecasts as the euro zone crisis threatens to tip an economy that is haemorrhaging jobs into recession.
Presenting the latest inflation report, Bank Governor Mervyn King said conditions had deteriorated since August and that Britain's economy could stagnate until the middle of next year.
The central bank blamed zone leaders' failure to find a fix for the escalating debt crisis for euro the worsening outlook.
While King warned that there were limits to what the central bank could do, economists saw the gloomy predictions as a clear sign that more quantitative easing was on the cards, especially as the government's hands are tied by its pledge to erase a large budget deficit.
The Bank predicted inflation would fall to 1.3 percent by late 2013, well below its 2 percent target, despite the expansion of its asset purchase programme by 75 billion pounds to 275 billion pounds last month.
The bank also halved its near-term growth forecasts, and now sees a strong chance annual growth rates will be below 1 percent throughout most of 2012.
The outlook for growth for the world economy has worsened since August, King told a news conference. That is also true here in the United Kingdom, where activity could be broadly flat until around the middle of next year.
...Why have we revised down our projection this time? That's largely news from the euro area.
King's comments came after data showed the number of Britons without a job soared to a 17-year high of 2.62 million in September.
Youth unemployment jumped above the politically sensitive 1-million mark for the first time since records began in 1992, meaning more than one in five 16-24 year-olds is without a job.
The governor pressed for an effective solution to the crisis in the euro zone, as the central bank said even its downbeat growth outlook did not account for any worst-case outcome in Europe, which it deemed impossible to quantify.
Despite the worsening economic backdrop, Chancellor George Osborne has left little doubt he will resist calls to water down his austerity plan when he gives his autumn policy update later this month, and King supported the general mix of deficit reduction coupled with loose monetary policy.
Sterling fell and gilt futures erased losses in the aftermath of the BoE report, which supported economists' expectations that the central bank will add another 50 billion pounds of stimulus at the time of its next inflation report in February.
The Bank of England unleashed the full force of its dovish feelings, Nomura analyst Philip Rush said. Forecasts were revised lower and the gloomy message hammered home by Mervyn King, he said.
SQUEEZE ON LIVING STANDARDS
Britons have been suffering from the biggest squeeze on living standards in over 30 years due to prices rising much faster than wages and the jump in unemployment.
King said this should ease next year as inflation comes down, supporting consumer spending and encouraging growth. The Bank predicts inflation will fall below the 2 percent goal during 2012.
But the central bank warned that slowing global demand, concerns about the solvency of several euro area governments, and strains in banking and in some sovereign funding markets would weigh heavily on UK growth in the near term.
Moreover, even if euro zone policymakers come up with a plan to resolve the debt crisis, growth in Britain's largest trading partner was set to remain weak.
A failure to meet these challenges would almost certainly have significant implications for the UK economy, it said.
The Bank said its Monetary Policy Committee was divided over the likely strength of the recovery as well as the risks to inflation. It forecast growth would pick up to around 3.1 percent at the end of 2013.
King reiterated the Bank's long-held view that annual inflation, which eased to 5 percent in October, would fall sharply in the next six months and return to around target by the end of 2012 as one-off effects from this year's VAT rise fall out of the data.
(Additional reporting by Matt Falloon, Keith Weir, Stefano Ambrogi, Peter Griffiths, Olesya Dmitracova and Noami O'Leary; Editing by Ruth Pitchford, John Stonestreet)