Economy may be contracting after Olympics boost, says King

The Bank of England yesterday slashed its growth forecasts and hiked its inflation expectations, as Sir Mervyn King unveiled the gloomiest set of medium-term economic projections for the UK since the central bank won independence in 1997.

The Bank's Governor also warned that the economy, which emerged strongly from recession earlier this year, may already be contracting again, raising the prospect of a "triple-dip" recession. "Output may shrink a little this quarter," he said at the Bank's regular press conference.

The Bank's latest Inflation Report shows it expects growth to remain well below its historic trend rate over the next three years. It now does not see the UK regaining its pre-2008 level of output until 2015. It expects inflation to remain above 2 per cent throughout next year and not to fall to the official target level until 2014.

The Governor said the stark deterioration was a consequence of the ongoing eurozone crisis, which continues to make UK banks reluctant to lend, and unexpected hikes in world energy and food prices. The eurozone is expected to report this morning that the single currency area has returned to recession after contracting again in the third quarter, while in the UK, Mr King said: "It may be unreasonable to expect anything other than a slow and protracted recovery."

The labour market has been one of the few bright spots in the UK economy, with unemployment peaking at a considerably lower rate than in past recessions. But new official statistics yesterday suggested that even this light could be fading. Total employment grew by 100,000 in the third quarter of the year, a slower rate than in the previous quarter. And a monthly breakdown of the labour market figures shows that unemployment rose by 50,000 in September.

The UK economy grew by 1 per cent in the third quarter of 2012, pulling the UK out of its double-dip recession. But this strong figure was flattered by one-off factors, including Olympic ticket sales and activity shifted from the previous quarter when there was an extra bank holiday.

If the economy was to contract in the final quarter and there was negative output in the first three months of 2013, the UK would be back in recession for the third time since 2008.

Mr King said: "Continuing the recent zig-zag pattern, output growth is likely to fall back sharply in the fourth quarter as the boost from the Olympics in the summer is reversed."

The shadow Chancellor, Ed Balls, said: "This sobering report shows why David Cameron and George Osborne's deeply complacent approach to the economy is so misplaced."