The Bank of England cut U.K.'s growth estimate as fiscal consolidation and Eurozone debt crisis weigh on demand. Moreover, a below-target inflation forecast added hopes of more asset purchases by the year end.
In its quarterly Inflation Report released Wednesday, the central bank said economic growth is likely to be around 2 percent in two years, down from the 2.6 percent expansion estimated in May.
"The impact of the euro-area debt crisis, together with the fiscal consolidation and tight credit conditions at home, is likely to continue to weigh on demand," the report said. The bank said the outlook for growth remains unusually uncertain.
The biggest threat to recovery stems from the risk that an effective policy response is not implemented sufficiently promptly in the euro area, the Bank of England said. The central bank expects the Funding for Lending Scheme and quantitative easing to spur a modest recovery.
The U.K. economy is navigating through tough waters, Governor Mervyn King said. Efforts to rebalance the economy will require patience, he added.
The economy fell deeper into recession in the second quarter. Gross domestic product dropped 0.7 percent from a quarter ago on an extra public holiday and poor weather. King expects to see a rebound in the third quarter GDP.
Inflation is forecast to fall further throughout the year. Now, inflation is seen near 1.7 percent in two years time, which is below the central bank's 2 percent target.
The central bank said the near-term outlook for inflation is lower than three months ago. The downgrade reflects fall in energy prices and some broader-based weakness in price pressures.
Inflation is a little more likely to be below than above the 2 percent target for much of the second half of the forecast period, the bank said. According to central bank, the risks to inflation around the target are judged to be broadly balanced by the end of the forecast period.
The Inflation Report has kept the door open for more quantitative easing. The bank increased its asset purchase programme by GBP 50 billion in July. Economists now expect the bank to act further, once the current tranche of bond purchases get fully utilized by early November.
IHS Global Insight's economist Howard Archer said it is more likely that interest rate will stay at 0.50 percent through until at least late-2014.
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