Nov. 15 (Bloomberg) -- Bank of England Governor Mervyn King said inflation could fall more sharply than currently expected due to spare capacity and “substantial risks” to the outlook for the global economy.
“While we can be confident about the direction of change of inflation over the coming months, we remain uncertain about the precise pace and extent,” King said in a letter to Chancellor of the Exchequer George Osborne published in London today. It is “possible that inflation could fall back more sharply given the existing margin of spare capacity in the economy, the substantial risks around the global economic recovery and the implications” for the U.K.
Data today showed inflation last month eased more than economists forecast to 5 percent. The Bank of England is in the second of a four-month program of bond purchases it started in October to support the recovery, and King said the Monetary Policy Committee “stands ready to respond accordingly to changes in the balance of risks to the inflation outlook.”
The pound extended its decline against the dollar after King’s letter was published before regaining some ground. It traded at $1.5852 as of 10:46 a.m. in London, down 0.4 percent on the day.
While inflation remains above the central bank’s 2 percent limit, King said policy makers expect it to slow “sharply” in the next six months and reach the goal by the end of 2012. The Bank of England left the target for asset purchases at 275 billion pounds ($436 billion) this month after increasing it by 75 billion pounds in October. It also kept its benchmark rate at a record low of 0.5 percent.
With the economy under pressure from the government’s budget squeeze and Europe’s sovereign debt turmoil, King will face questions at a press conference tomorrow on the central bank’s use of so-called quantitative easing to prevent another recession.
King will be presenting the Bank of England’s Inflation Report including new economic projections. In August, it forecast that consumer-price gains would slow below its 2 percent target by the first quarter of 2013.
“The main risk facing the U.K. economy continues to come from the uncertain global economic outlook, and the extent to which weaker global economic conditions threaten the recovery,” King said today. “The MPC can use bank rate or asset purchases to help case the adjustment of the U.K. economy to these shocks, but there is a limit to what it can achieve when real adjustments are necessary.”
‘Need to Act’
In his response to King, Osborne said the risk to the U.K. from the euro-area crisis is “very serious,” adding that the region has the “financial capacity to restore stability.”
“I understand that the balance of risks around the medium- term outlook for U.K. inflation has changed as a result of world growth slowing and the increased uncertainty about the prospects for the global economy, and in particular the euro zone,” Osborne wrote. “The institutions and leaders of the euro zone need to act without delay” to resolve the crisis.
Europe’s economic expansion failed to accelerate in the third quarter as the region braces for a recession sparked by the debt crisis. Gross domestic product increased 0.2 percent from the previous three months, when it rose at the same pace, the European Union’s statistics office in Luxembourg said today. In the U.K., surveys this month showed manufacturing output shrank in October and services growth cooled.
European stocks fell for a second day as Italy’s premier- in-waiting Mario Monti struggled to get political parties to help form his new Cabinet and work on reducing the euro area’s second largest debt burden. The Stoxx Europe 600 Index fell 1.3 percent and the FTSE 100 Index in London declined 1 percent.
Economists had forecast that U.K. inflation would ease to 5.1 percent in October, according to the median of 33 estimates in a Bloomberg News survey.
On the month, consumer prices rose 0.1 percent, the statistics office said. Food prices dropped 0.9 percent, the biggest monthly decline for an October since 1996. Transport costs fell 0.7 percent and petrol prices slipped 0.4 percent.
The data showed core annual inflation, a measure that excludes alcohol, food, tobacco and energy prices, accelerated to 3.4 percent in October from 3.3 percent in September. Retail- price inflation, a measure used in wage negotiations, eased to 5.4 percent from 5.6 percent.
“We are now over the worst” for inflation and “potentially we’ll get down to 2 percent by the end of next year,” said Adam Chester, head of U.K. macroeconomic research at Lloyds TSB Corporate Markets in London. “It’s ‘touch and go’ whether the U.K. goes into recession in the next six months and the BOE will be looking to insure against that.”
--With assistance from Mark Evans and Fergal O’Brien in London and Joel Rinneby in Stockholm. Editors: Fergal O’Brien, Craig Stirling
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