Euro crisis leaves door ajar for more BoE easing

LONDON (Reuters) - Bank of England Governor Mervyn King left the door open for more support for the struggling economy on Wednesday despite higher inflation in the near term as the escalating dangers from the euro zone debt crisis pose risks to a gradual recovery.

The central bank took a gloomier view of growth ahead, though it surprised observes by lowering its medium-term inflation prediction - a sign that while more stimulus is not immediately on the cards it could come if conditions worsen.

The economy has not fully recovered from its 2008-2009 slump that left many Britons poorer. But the central bank opted to halt the money printing press last week although the economy slipped back into recession earlier this year.

"We don't know when the storm clouds will move away. But there are good reasons to believe that growth will recover and inflation will fall back," he told a news conference, presenting the bank's latest forecasts.

But King warned against the long and treacherous road ahead.

"We have been through a big global financial crisis, the biggest downturn in world output since the 1930s, the biggest banking crisis in this country's history, the biggest fiscal deficit in our peacetime history and our biggest trading partner, the euro area, is tearing itself apart without any obvious solution," he said.

"The idea that we could reasonably hope to sail serenely through this with growth close to the long-run average and inflation at 2 percent strikes me as wholly unrealistic. We're bound to be buffeted by this and affected by it."

AUSTERITY

The lack of growth in Britain has led to criticism of the Bank and Britain's Conservative-led government, part-way through a five-year austerity programme which it is finding harder to defend as growth in Britain and the euro zone falters.

Most economists think that the central bank will be reluctant to engage in another round of asset purchases with newly created money, known as quantitative easing, after buying a total of 325 billion pounds in gilts, as inflation has proven stickier than so far forecast.

But King said more stimulus remained an option, and analysts took the unexpectedly low two-year inflation forecast as a sign that the policymakers had room to do more if needed.

"That back door to more QE is still firmly wedged open," Investec analyst Victoria Cadman said.

Sterling fell to a fresh four-week low against the dollar and a session low against the euro, while gilt futures reversed losses after the quarterly inflation report gave a weaker growth outlook.

Britain's economy shrank again in the first quarter and the central bank indicated that an extra day off for the Queen's Diamond Jubilee would hit growth in the second quarter.

Business surveys have painted a more positive picture of the economy and, in another sign of some underlying resilience, the number of Britons out of work fell at the fastest pace in nearly a year in the three months to March.

Like in previous Inflation Reports since the crisis, the central bank had to revise up its near-term inflation forecast and cut its growth outlook.

Inflation was now likely to remain above the 2 percent target for the next year or so, it said. In two years' time, inflation is forecast to be around 1.6 percent, compared to 1.8 percent in the Bank's February forecast.

At this point, annual growth will have recovered to around 2.7 percent, about 0.3 percentage points lower than previously forecast. As well as high inflation, there will also be headwinds to growth from tight credit and public spending cuts, the Bank said.

(Additional reporting by Peter Griffiths, Michelle Martin, Olesya Dmitracova and Yeganeh Torbati; writing by Sven Egenter. Editing by Jeremy Gaunt.)

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