May 16 (Bloomberg) -- Bank of England Governor Mervyn King said officials have prepared for dangers posed by Europe’s debt crisis, after the bank lowered growth forecasts and raised predictions for inflation this year.
“Contingency plans have been discussed and have been for a considerable time,” King said at a press conference to present the bank’s quarterly Inflation Report today in London. “We are navigating through turbulent waters with the risk of a storm heading our way from the continent.”
Greece is heading for new elections after a political stalemate that’s sent stocks lower, pushed up bond yields and raised concern the nation may leave the euro area. King said the currency region is facing a prolonged period of “sluggish” growth that will affect the U.K. and that the bank hasn’t ruled out responding with more stimulus if needed.
Policy makers voted to stop increasing bond purchases last week after some officials stepped up their rhetoric on inflation, which has been above their goal for more than two years. King said today that there’s a case both to expand bond purchases or to hold fewer securities and that the risks to inflation in two years are “broadly, evenly balanced.”
“The asset purchases we made between October and last month will continue to stimulate the economy for some time to come,” King said. “The fact we’ve not continued the program at this stage doesn’t mean to say the effect doesn’t continue to pass through the economy -- it does -- and the option is still open to us also.”
Inflation will be about 1.6 percent in two years after staying above the 2 percent target for longer than it predicted in February, the central bank’s forecasts show. Officials also said that U.K. growth is likely to remain “subdued” in the near term, held back by the government’s fiscal squeeze, the pace of the global economy and tight credit conditions.
Gross-domestic-product growth is seen at about an annual 2.6 percent in two years, according to the forecasts. The bank publishes its quarterly predictions in the form of fan charts without specifying exact numbers. It will release data indicating exact figures next week.
David Tinsley, an economist at BNP Paribas in London, said the two-year inflation forecast “puts QE back on the table” and he sees a 45 percent probability of more stimulus by July. Malcolm Barr, an economist at JPMorgan Chase & Co., forecasts a 50 billion-pound ($80 billion) increase in QE in August, saying that U.K. growth and euro area concerns “are likely to linger through the summer even in best case scenarios.”
Ten-year gilts rose after the release of the inflation report, pushing the yield to a record low of 1.821 percent. The yield was at 1.891 percent as of 3:42 p.m. in London. The pound fell 0.4 percent to $1.5924.
The Bank of England held its key interest rate at a record low of 0.5 percent on May 10 and kept its bond-purchase target at 325 billion pounds. Officials said today that despite the changes in the near-term outlook, “the fundamental policy challenges” after the financial crisis and recession have stayed the same.
“There are major problems ahead,” King said. “There are major credit losses to be realized. Whatever happens there will be difficulties ahead that will undoubtedly affect us” and “it is not sensible to think solely in terms of ‘euro stays together -- excellent. Euro comes apart -- disaster,’” he said.
“I don’t think anyone is under any illusion that we’re not all going to be affected by this,” King said. “Our banking system is exposed to the euro area. We certainly are going to be affected.”
In the Inflation Report, the central bank said concerns about the “possibility of a disorderly resolution” in the euro area have “adversely influenced asset prices, bank funding costs and confidence. Even if a disorderly outcome is avoided, the possibility of such ‘‘extreme outcomes crystallizing will continue to weigh on U.K. activity.’’
Britain’s economy shrank 0.2 percent in the first quarter after a 0.3 percent contraction in the previous three months. Bank of England chief economist Spencer Dale said surveys and other reports suggest underlying growth is stronger and the official GDP data may be revised up.
While the euro threats are mounting, so too are inflation concerns, with consumer price growth accelerating to an annual 3.5 percent in March from 3.4 percent the previous month.
Deputy Governor Paul Tucker said April 18 that the ‘‘uncomfortably above target’’ rate could hold above 3 percent into the second half of the year. Minutes of the May 9-10 policy meeting will be published on May 23.
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