Soaring prices and stagnant growth: Grim outlook for UK economy as Bank of England warns inflation to top 3% by summer

• Bank blames higher tuition fees and energy costs for inflation pressures
• Inflation could remain above the two per cent target for another two years
• Pound slumps another 1 per cent versus euro
• But GDP growth could rise to around 2% by the end of 2014, Bank predicts

High inflation combined with stagnant economic growth mean households will soon suffer an even tighter squeeze on their budgets, the Bank of England warned today.

Presenting the Bank's Inflation Report, Governor Sir Mervyn King blamed soaring utility bills and university tuition fees for price pressures but said he was prepared to tolerate 'stubbornly high' inflation in order to safeguard the UK's economic recovery.
The Bank has been criticised since the financial crisis for failing to bring down inflation, which is running at 2.7 per cent. Today the Bank forecast it to rise above three per cent by the summer, and said it could remain above the two per cent target for another two years.

Inflation woes: Consumer price index inflation is likely to rise over the next couple of years before falling again, according to the latest forecasts (Source: Bank of England)

Sir Mervyn said: 'Attempting to bring inflation back to target sooner would risk derailing the recovery and undershooting the target in the medium-term.
'So long as domestic cost and price pressures remain subdued, we will continue to look through the temporary, albeit protracted, period of above-target inflation in order to support the recovery in growth and employment.'

'In the short run we'll have to accommodate this, it's not desirable, but that's the hand we have to play,' he added.
Bank blamed higher tuition fees and energy costs for recent inflation pressures, saying they had added around 1 per cent to CPI at the end of last year, and would continue to drive inflation higher.
Philip Shaw, chief economist at Investec Securities, questioned whether the Bank could become more flexible with its monetary policy.
'With inflation above the 2 per cent target for 90 per cent of the time over the past five years, the Monetary Policy Committee has already been flexible,' he said.
'How this might become even more flexible is not clear at all,' he added.

Feeling the pinch: Household budgets are set for further squeezes as inflation is predicted to rise

Sterling's recent weakness had added to inflation woes and there was a further sharp fall in the pound today after Sir Mervyn said the Bank stood ready to take action to help the economy. The pound slumped to a fresh six-month low against the dollar and dipped nearly 1 per cent against the euro.
Currency expert Eimear Daly, head of market analysis at Monex Europe, said: 'The most likely conclusion is that the Bank of England will use monetary easing to devalue the pound in order to boost exports, as private demand is now immune to further quantitative easing.'
High inflation threatens to keep up the pressure on already straitened household budgets as the rising cost of goods continues to outpace increases in average earnings. Average earnings rose by just 1.3 per cent over the year to October, according to the most up-to-date data from the ONS. 
Families have already faced three or four years of squeezed spending power thanks to the attack from rising prices on households' income and savings.
While the consumer prices index inflation has been at 2.7 per cent since October, figures released yesterday revealed that households have suffered faster rises among essential items such as energy, food and rent.

Sluggish growth: GDP is predicted to remain broadly flat for many months to come, according to today's report (Source: Bank of England)

The Office for National Statistics added that inflation as measured by the retail prices index had accelerated to 3.3 per cent from 3.1 per cent a month before.
But despite the gloom Bank of England governor Sir Mervyn King insisted a ‘recovery is in sight’ while warning the path ahead for the UK economy will not be smooth.
Presenting the Bank's quarterly inflation report, Sir Mervyn said there was cause for optimism despite the worse than expected contraction in GDP in the fourth quarter of 2012.

He added that while GDP has remained broadly flat for two years now, the headline figures mask a ‘more encouraging underlying picture’.

The Bank said a ‘slow but sustained recovery’ would be supported by an easing in wider global conditions as well as its multibillion-pound Funding for Lending (FLS) scheme, which is boosting credit for consumers and businesses.

Why prices have risen: Graph showing the contributions to inflation over the past year (Source: Bank of England)

Its forecast shows annual GDP growth rising to around 2 per cent by the end of 2014 and remaining in positive territory despite some volatility in the year ahead.
Sir Mervyn said: ‘The UK economy is therefore set for a recovery. That is not to say that the road ahead will be smooth. This hasn't been a normal recession and it won't be a normal recovery.’
The Bank does not expect a triple-dip recession but said GDP was likely to continue at below pre-financial crisis levels for around another two years.
The report will help ease fears over the economy after the 0.3 per cent contraction in the fourth quarter left the UK on the brink of its third recession since 2008.
Although inflation remains high, Sir Mervyn warned that attempting to bring it back to target would ‘risk derailing the recovery’.
He added: ‘So long as domestic cost and price pressures remain subdued, we will continue to look through the temporary, albeit protracted, period of above-target inflation in order to support the recovery in growth and employment.’

Food prices have been rising in recent months, contributing to increases in the rate of inflation (Source: Bank of England)

The high inflation forecast means that one of incoming Bank governor Mark Carney's first tasks could be to write a letter to the Chancellor to explain why inflation is more than 1 per cent above target.
Sir Mervyn admitted that the Bank's £375 billion quantitative easing programme had become less effective but said that the Bank stood ready to do more to support the recovery.
The FLS - launched last year to provide cheap money to lenders - is among the tools being used to boost the economy and today's report adds to recent encouraging signs that it is beginning to work.
Lending costs are starting to come down and Halifax house prices recorded their strongest quarterly rise in three years in the three months to January.
Despite measures being taken in the UK, Sir Mervyn said there needed to be a recovery in the global economy for a return to stable growth.
He said: ‘The experience of the past five years has shown us that UK monetary policy alone cannot guarantee a stable path for our economy, especially after a banking crisis. The challenge of rebalancing the world economy means that our road to recovery will be harder than in 1993. But recover we will.'

Oil and gas prices have been increasing in recent months, putting extra strain on already squeezed household incomes and contributing to the rising rate of inflation (Source: Bank of England)