The Bank of England has lowered its forecasts for UK growth and inflation as the eurozone sovereign debt crisis and weakening global demand weigh on the domestic economy. Annual growth rates are likely to fall below 1% in 2012, the bank said, and inflation should drop below 2% by the end of next year.
The bank's monetary policy committee (MPC) has a range of views about the strength and timing of a recovery, but the "best collective judgement" is that by 2013, growth will return to levels above its historical average. However, there are significant - and unquantifiable - downside risks from the ongoing deadlock in the eurozone.
"Implementation of a credible and effective policy response in the euro area would help to reduce uncertainty and so support UK growth, but its absence poses the single biggest risk to the domestic recovery," the Bank said.
However, it added that even if a solution is found in the near term, the weakness in the eurozone's economies will mean that demand will remain low and exports will suffer.
The UK economy grew at an unexpectedly fast rate of 0.5% in the third quarter of 2011, beating forecasts. However, this was largely a reaction to a very weak second quarter, which was hit by global factors, including the Japanese tsunami, and softer domestic demand.
At IHS Global Insight, chief UK and European economist Howard Archer said that the projections indicate that the bank thinks a contraction is a real possibility.
"While the Inflation report and Sir Mervyn King did not specifically use the 'R' word - Recession - the implication is that this is a very real risk, particularly if events in the Eurozone worsen and credit conditions tighten," he said.
Consumer price inflation (CPI) hit 5.2% in September due in a large part to rising energy costs and an increase to value added tax (VAT). However, as softer demand hits sales, energy and import prices fall back and the weak labour market reduces spending, that number is more likely than not to fall to below the bank's target rate of 2%, according to MPC projections.
With growth low and inflation peaking, the MPC voted unanimously to inject a further £75bn into the UK's financial system in October, taking its total asset buying programme to £275bn. If inflation does moderate and the economy shows few signs of growing, the bank may consider a further round of quantitative easing (QE).
"Given that consumer price inflation is seen appreciably below its 2.0% target level on the two-year policy horizon and beyond on the assumption that interest rates stay unchanged for essentially the next two years and the stock of quantitative easing is limited to £275bn, this strongly implies that the Bank of England will undertake more stimulative action," Archer said. "This seems certain to be through more Quantitative Easing as there seems little desire within the Bank of England to take interest rates below 0.50%. Indeed, it is notable that even at the height of the 2008/9 recession, the Bank of England did not lower interest rates below 0.50%."