UPDATE 1-BoE sees slower UK recovery than previously thought

LONDON, May 13 - British inflation will be just above 1 percent in 2 years, and the economy will recover more slowly than previously thought, the Bank of England said, although there are big risks in both directions.

Sterling fell almost a cent against the dollar, Britain's top FTSE 100 share index fell and gilt futures rose after the BoE's Inflation Report on Wednesday suggested monetary policy will need to remain loose for some time to come.

BoE Governor Mervyn King said he was "certainly" not disappointed with the impact of its quantitative easing programme to pump extra money into the economy but stressed high uncertainty surrounding the BoE forecasts.

"Growth has just as much chance of being positive over the next 12 months as it has of being negative," King told reporters.

In its quarterly forecasts, which factor in market rates and its 125 billion pounds asset purchase programme, the BoE sees inflation troughing at around 0.5 percent at the end of 2009 before picking up to around 1.2 percent in 2 years time.

That is still well below the official 2 percent target.

GDP is seen troughing with an annual fall of around 4.5 percent at the start of the second quarter of this year, with growth then resuming at the start of 2010 before hitting a rate of around 2.5 percent in 2 years time.

The GDP forecasts show a flatter trough and growth resuming slightly later than in February's report, suggesting interest rates will need to be kept lower for longer and perhaps increasing the size of its quantitative easing programme.

"The message here is that they are going to be in no hurry at all to start to tighten policy, whether that is through a reversal of QE (quantitative easing) or higher interest rates", Jonathan Loynes of Capital Economics said.

"It seems to me to inject a bit of caution amidst all the talk of green shoots of recovery."

OPPOSING FORCES

King said the prospect of necessary fiscal consolidation in many countries after the downturn would put a drag on recovery.

"The outlook for domestic activity and inflation continues to be dominated by the balance between opposing forces," the BoE said in its report.

Weak global demand, the adjustment of the UK economy and weak bank lending were being countered by considerable economic stimulus, weak sterling, past falls in commodity prices and actions to improve the availability of credit.

The BoE said the world economy remained in deep recession and trade fell precipitously but there were promising signs the pace of decline both at home and abroad had begun to moderate.

It said the timing and strength of the recovery was highly uncertain but on balance the economic stimulus already in train pointed to "a relatively slow recovery".

"The projected distribution for GDP growth is weaker than in the February report, reflecting lower-than-expected activity in the first quarter of 2009 both at home and abroad and a judgement that it is likely to take longer for bank lending to return to normal than assumed in February."

The BoE said it would take time to assess the impact of its QE programme and it will be many months before the effect will show in GDP data.