Nov. 14 (Bloomberg) -- The Bank of England signaled there is room to cut its benchmark interest rate at least once next year to prevent an economic slowdown without boosting inflation.

The inflation rate will settle to the bank's 2 percent target in 2009 after rising above it next year, the central bank said. Its forecasts are based on market assumptions the bank will cut the main rate a quarter point to 5.5 percent in the first quarter. Growth risks are ``on the downside,'' and inflation risks are ``balanced,'' the bank said.

``The central projection is for growth to slow sharply in the next year,'' Bank of England Governor Mervyn King said at a press conference in London today. ``There has been some tightening of credit. Residential and commercial property investment are likely to moderate, possibly quite sharply.''

Britain's economy is cooling from its fastest growth since 2004 after the Monetary Policy Committee lifted the key lending rate to a six-year high. House prices are falling, and service industries expanded at the slowest pace in 4 1/2 years after contagion from the U.S. subprime mortgage market slump spread.

``The report gives a clear signal that a series of interest rate cuts lies ahead,'' said Vicky Redwood, an economist at Capital Economics Ltd. ``The MPC will wait until early next year to cut.''

Forecast Rates

If policy makers hold the rate at 5.75 percent, inflation will undershoot the target in two years, the forecasts show. They assume that the key rate averages 5.3 percent in the second half of 2008.

The pound fell after the report, dropping 0.0053 of a dollar to $2.0681 at 12:53 p.m. It had traded as high as $2.0844 earlier in the day. Bonds pared earlier losses, with yields on the 2-year gilt falling 1 basis point to 4.8 percent.

``Further financial market fallout, either at home or overseas, poses the biggest downside risk to activity,'' the report said. ``But the impact of that risk on inflation needs to be weighed against the upside risks from higher energy and commodity prices, and from wages and inflation expectations.''

Weekly salary data show pay pressures are increasing even though that effect can't be seen as much in three-month figures, King said today. Average earnings including bonuses rose an annual 4.1 percent in the quarter through September, the highest since March and up from 3.7 percent in the period through August, the statistics office said today. Without bonuses, wage growth was unchanged at 3.7 percent.

Unemployment Drop

Unemployment fell to the lowest in more than 2 1/2 years in October, as quicker economic growth spurred companies to hire workers, the report also showed.

Claims for unemployment benefits dropped 9,900 from September to 824,000, the least since February 2005, the Office for National Statistics said. The median forecast in a Bloomberg News survey of 29 economists was for a decline of 6,000. The jobless rate was unchanged at 2.6 percent.

``The picture on the labor market is going to turn,'' Kenneth Wattret, a senior economist at BNP Paribas, said in an interview. ``It wouldn't be a surprise if in the next few months small negatives on unemployment turned into small increases.''

King dodged questions about his role in the rescue of Northern Rock Plc, which tapped the central bank for emergency funding in September, saying he would talk to members of Parliament on the Treasury Committee about the matter in the weeks ahead. He also set aside questions about whether he would be reappointed as governor when his term expires next year.

`This Can Wait'

``Everyone involved in this, including myself, has had more important things to worry about,'' King said in response to a question about whether he wanted another five-year term. ``We're talking about next July. This can wait until the new year and I think it should.''

Asked whether he considered resigning, King said, ``No.''

The bank expects the annual pace of economic growth to ease to just over 2 percent in the middle of 2008 from more than three percent currently. It will then rise to about 2.8 percent by late 2009. In August, it forecast 3 percent growth in 2007, 2.6 percent in 2008 and 2.5 percent in 2009. The U.K. economy has grown without interruption since 1992.

The U.K. benchmark interest rate is the highest among Group of Seven countries. The U.S. Federal Reserve lowered the U.S. rate twice since August to 4.5 percent to cushion the economy against surging credit costs after banks became reluctant to lend money to each other.

Trade Deficit

``The U.K. has been a pale shadow of the issues confronting the U.S.,'' King said. ``We, too, have had a trade deficit, which has been much less than that of the U.S. What is interesting about the last three months, the sterling exchange rate has fallen most against the euro, whereas it's only 2 percent or so up against the dollar.''

King said he is increasingly concerned about ``tensions'' in currency markets, citing the refusal of China and other countries to allow their currencies to trade freely. ``All of us will want to discuss it at the Group of 20 meeting this weekend,'' he said.

King also said he's more concerned about the impact of a global equity-market slump on economic growth than writedowns in the banking industry.

``Equity prices are higher now than they were in August and in emerging markets they are 20 percent higher,'' said King. ``There must be some downside risks. It's that sort of risk that's the bigger risk to the global economy than the narrower one from the banking sector.''

To contact the reporter on this story: Brian Swint in London at bswint@bloomberg.net.

Last Updated: November 14, 2007 08:09 EST