Page last updated at 16:03 GMT, Wednesday, 10 February 2010

Bank of England warns inflation will exceed 3%

Mervyn King: "The UK economy has continued to bump along the bottom"

The UK's inflation rate will rise above 3% in the coming weeks, the governor of the Bank of England, Mervyn King, has predicted.

Presenting the Bank's quarterly inflation report, Mr King said the increase in VAT and higher petrol costs would push up prices.

But, he added, inflation would then quickly fall back below the 2% target.

The governor said that he expected "a gradual recovery" in the UK economy over the coming year.

In December the official rate of inflation reached 2.9%. If inflation moves above 3%, the governor is required to write a letter of explanation to the chancellor.

Cautious on growth

But according to the Bank of England's projections, inflation will fall again quickly and could remain below the 2% target for several years.

CPI inflation graph

The Bank remains cautious over the UK's prospects of growth.

"The UK economy has continued to bump along the bottom," Mr King said. "But a gradual recovery in output may now be in prospect."

He added that economic growth was unlikely to return to the levels seen before the economic crisis for "a considerable period".

The Bank of England's report said the UK's gross domestic product (GDP) - the value of goods and services produced - could grow by up to 3.5% by early 2012, though the strength of the recovery was still highly uncertain.

The Bank's £200bn programme of quantitative easing (QE) had helped economic recovery, Mr King said.

Although the programme was paused earlier this month, the governor refused to rule out further injections of liquidity into the economy, arguing that "it was far too soon" to rule out any further action.

Until the base rate starts to increase, there is no prospect of savers seeing any meaningful increases on the paltry interest returns they are currently receiving
Andrew Hagger, Moneynet

The QE programme, which involves feeding money into the economy by buying up assets with newly created money, began in March last year.

Mr King did rule out extending the special liquidity scheme, however, which had provided banks with emergency cash at the peak of the financial crisis.

"The position has changed a lot since this scheme was introduced," he said.

"It is the most generous scheme in the world [and] we are working with the Financial Services Authority and individual banks to ensure they have schedules for refunding this money."

There was a muted reaction to the governor's comments on the stock markets, with the FTSE 100 - which lists the leading 100 companies traded on the London Stock Exchange - rising by 0.3%.

Investors indicated the report had held few surprises, with interest rates expected to remain low for the foreseeable future.

Continued low rates are resulting in poor returns for savers, with a number of the best deals being pulled already in 2010.

"Until the base rate starts to increase, there is no prospect of savers seeing any meaningful increases on the paltry interest returns they are currently receiving," said Andrew Hagger, of Moneynet.

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