The Bank of England says the economic downturn in the UK has started to moderate but warns the timing of a full recovery is still uncertain.
In its latest inflation report, which outlines expectations for inflation and the base rate, the central bank notes that the world economy remains in “deep recession” with banking and financial systems fragile and lower levels of international trade.
But it points to “promising signs”, with the pace of the decline starting to slow. “There is considerable economic stimulus stemming from the easing in monetary and fiscal policy at home and abroad, the substantial depreciation in sterling, past falls in commodity prices, and actions by the authorities internationally to improve the availability of credit,” the Bank of England states.
However, offsetting this is “the process of adjustment under way in the UK economy” – this includes individuals increasing the amount they save and reducing their spending, while banks restructure their balance sheets.
“[This] will continue to act as a significant drag on economic activity,” the Bank of England says.
Although the central bank does predict the UK economy will start to grow again in 2010, it warns that a full and sustained recovery is likely to be slow and prolonged.
The latest inflation figures recently revealed that the cost of living, as measured by the Retail Prices Index (RPI), turned negative in March for the first time since 1960. It is now -0.4%, down from 0% in February.
The Consumer Prices Index (CPI) – the official measure of inflation that, unlike the RPI, does not include mortgage interest payments – fell to 2.9% in March, down from 3.2% in February and 3% in January.
The Bank of England’s inflation report notes that CPI still remains well above its 2% target but is likely to drop to below target later in the year as a result of cheaper food and fuel.
Wages are also expected to fall – this has already started, with the latest unemployment figures revealing the first fall in wages since 1996.
However, the Bank of England adds that there is a substantial risk that inflation could actually rise. “The significant depreciation of sterling has raised companies’ import costs. The extent to which the adjustment to sterling’s depreciation will come through higher prices rather than lower wages is a key uncertainty surrounding the inflation outlook.”
Jonathan Loynes, chief European economist at Capital Economics, says the inflation report shows "sensible caution" against those that are calling a recovery.
"The clear message is that any renewed tightening of policy – either in the form of a reversal of quantitative easing or a rise in the base rate – is a long way off," he adds.