LONDON – The Bank of England said Wednesday the British economy was probably already in recession and faced a distant risk of deflation as a global financial crisis takes its toll.
At a press conference following the BoE's latest quarterly economic outlook, the central bank's governor, Mervyn King, said the Bank of England was prepared to cut interest rates again after they were slashed by a third to 3.0 percent last week.
"The economy probably entered recession in the second half of 2008 and output is likely to contract further," the central bank said in its latest quarterly report.
The Bank of England meanwhile used a chart to forecast a risk to British deflation in late 2009 should British interest rates remain at the current rate of 3.0 percent.
The report's chart "shows a significant probability of deflation," said Jonathan Loynes, chief European economist at Capital Economics in London.
Deflation is a protracted general fall in prices and a signal of serious recession of which it may become a perpetuating factor. Disinflation, by contrast, is a slowing of inflation.
Britain is not officially in recession unless it reports two quarters running of negative gross domestic product (GDP) growth, or contraction.
The country's economy shrank 0.5 percent in the three months to September from the previous quarter, marking the first contraction since 1992, according to recent official data.
"Business surveys and reports from the Bank's regional agents weakened markedly and pointed to a further contraction in output in the fourth quarter," the BoE said on Wednesday.
It added that the British economy was set to contract two percent by the middle of 2009, before recovering, if rates remained at 3.0 percent
However analysts said British borrowing costs were certain to fall far below that level in the coming months.
The Bank of England's economic outlook report "is extremely downbeat, and leaves absolutely no doubt that further substantial interest rate cuts lie ahead, almost certainly starting in December," said Howard Archer, chief Britain economist at IHS Global Insight.
The British pound on Wednesday fell to an all-time low against the euro on the prospect of further monetary loosening.
The euro rose to 0.8215 pounds, or 82.15 pence -- the highest level since creation of the European single currency in 1999.
Loynes of Capital Economics said he expected rates to hit one percent, or even lower, in the months ahead, as Britain suffers a recession amid rising unemployment.
Britain's unemployment rate jumped to an 11-year high point of 5.8 percent in the three months to September, official data showed on Wednesday.
"We are certainly prepared to cut... (the BoE's key lending) rate again if it is necessary," King meanwhile told reporters.
The BoE's huge rate cut last week took markets totally by surprise and left British borrowing costs at their lowest level since 1955. The size of the reduction was the biggest since March 1981.
British 12-month inflation stands at a 16-year high of 5.2 percent but it set to tumble in the coming months owing to sliding energy and food prices, analysts said.