The governor of the Bank of England, Sir Mervyn King, says the economy is recovering but inflation will be higher than previously forecast.
In his quarterly economic forecast, Sir Mervyn said there was “cause for optimism”, as a “slow but steady recovery in output” takes hold.
But he warned that the recovery would not be smooth. “This hasn’t been a normal recession and it won’t be a normal recovery.”
The bank is not expecting a triple-dip recession and forecasts that output will rise to around 2 per cent by the end of 2014 and remain in positive territory.
The economy shrank by 0.3 per cent at the end of last year, raising fears that Britain could be heading into its third recession since 2008.
The governor said the outlook for inflation was higher than the bank had forecast in November.
The bank expects the consumer prices index (CPI) measure of inflation to rise to 3 per cent or more by the summer and remain above the 2 per cent target for another two years.
To combat rising inflation, the bank has the option of increasing interest rates. But Sir Mervyn signalled that this was not likely in the near future because of the weak state of the economy.
“Attempting to bring inflation back to target sooner would risk derailing the recovery and undershooting the target in the medium term.”
The latest figures, published yesterday, show that CPI held firm at 2.7 per cent in January for the fourth month in a row.
“This hasn’t been a normal recession and it won’t be a normal recovery.” Bank Governor Sir Mervyn King
But the retail prices index (RPI) measure, which includes housing costs, rose to 3.3 per cent in January from 3.1 per cent in December.
Sir Mervyn said rises in university tuition fees and energy bills had pushed up inflation.
Rising prices mean that one of the first tasks faced by Sir Mervyn’s successor, Mark Carney, is the prospect of writing a letter to the chancellor to explain why inflation is more than 1 per cent above target.
The pressure on living standards was confirmed by new figures from the Office for National Statistics which show that average earnings in 2012 were at roughly 2003 levels.
The figures, published today, reveal that wages peaked in 2009, but have been falling since then as inflation outstrips pay increases.
Asked about the figures, Sir Mervyn said it was impossible to “give a definitive prediction” of when real wages would start to rise.