The Bank of England has sharply cut its forecast for medium-term growth in Britain's economy due to worries that factors hurting growth since the financial crisis may be more long-lasting than first thought.
In its quarterly Inflation Report, the Bank said that growth in two years time was likely to be around 2 per cent a year, down sharply from the forecast of 2.67 per cent just three months ago.
This marks a break with previous Bank forecasts, which have usually shown strong rebounds in growth, even after short-term weakness.
"GDP growth in the second half of the forecast period is more likely to be below than above its historical average rate. That outlook is weaker than in the May report, reflecting the possibility that the factors contributing to the weakness of growth since the financial crisis may persist," the report said.
Britain's economy entered its second recession in four years at the end of 2011, as the euro zone debt crisis and government austerity measures increasingly weighed on the economy.
Official data last month showed that output slumped 0.7 per cent in the second quarter of 2012, as unusually wet weather and an extra public holiday worsened these underlying problems.
To mitigate this slowdown, the Bank restarted its program of asset purchases in July, committing to buy a further £50-billion ($78-billion U.S.) of British government bonds over the following four months, taking the total to £375-billion.
The Bank and the government have also launched a joint scheme to give banks cheap financing if they lend to home-buyers and businesses, and also to ensure banks have access to emergency funds if liquidity dries up in a crisis.
The Bank said that Britain's economy was likely to pick up modestly in the short term, due to real income growth as a result of lower inflation, and the benefits of asset purchases and the Funding for Lending Scheme.
Inflation hit a three-year peak of 5.2 per cent in September last year, but has fallen sharply since, dropping to 2.4 per cent in June. The Bank forecast that inflation would fall further in the short term, to around 2.1 per cent in the last three months of 2012, but then might rise slightly before averaging below 2 per cent from late 2013 onwards.
However, the Bank said it was more concerned than before that weak growth would not necessarily lower inflation. This is something that would limit its ability to stimulate the economy in future.
"The weakness in demand growth in recent years appears to have been accompanied by below par supply growth," it said.
"Some of the sources of uncertainty affecting the outlook for growth may have only limited implications for spare capacity and hence inflation," it added.
In two years time, the Bank forecast inflation would be just below 1.7 per cent, with broadly balanced risks of it being above or below 2 per cent.
The euro zone debt crisis remained the key risk for Britain's economy, it said.
Britain's Conservative-led coalition is part-way through an austerity programme that is scheduled to last for another five years, and which it is finding harder to defend as growth in Britain and the euro zone falters.
In February, the Bank forecast that inflation would fall below 2 per cent by the end of 2012.