Zero-growth forecast for economy

The economy will grind to a halt this year as the threat from the eurozone, tough austerity measures and tight lending conditions drag on the economy, the Bank of England has warned.

In its quarterly inflation report, the Bank slashed its growth forecast for 2012 to around zero from 0.8% in its May report, while the economy is now expected to grow by around 1.9% in 2013, compared to 2.4% in its last estimate.

The downbeat outlook will increase the chances of further emergency support measures, including a possible interest rate cut beyond the current record low of 0.5% and a further cash injection to the Bank's quantitative easing programme.

In a boost to borrowers, the Bank signalled that it did not expect interest rates to rise above 0.5% until 2015.

Presenting the gloomy report, Bank governor Sir Mervyn King said: "The underlying picture is that output has been at best broadly flat over the past two years, and has continually disappointed expectations of a recovery."

Sir Mervyn warned that the UK was "navigating rough waters and storm clouds continue to roll in from the euro area".

But he said the contraction in output over the last three quarters - signalling the longest double-dip recession since the 1950s - is probably not as weak as suggested.

He said the extra bank holiday in June for the Diamond Jubilee celebrations will have reduced output by around 0.5 percentage points and should unwind in the third quarter.

The governor also raised doubts over the accuracy of official construction figures which are "at odds" with other survey data.

Sir Mervyn said early indications on the £80 billion "funding for lending" scheme to unclog the flow of credit were positive, with some banks cutting their loan rates.

But he warned: "The economy will continue to face headwinds over the forecast period, from the fiscal consolidation and tight credit conditions at home, as well as from the difficulties in the euro area and a broader slowing in the world economy."

The euro area is hitting demand for UK exports and efforts to rebalance the economy "will require patience", Sir Mervyn said.

"GDP growth is more likely than not to be below its historical average rate in the second half of the forecast period.

"As I have said many times, the recovery and rebalancing of our economy will be a long, slow process."

The Bank's report said the near-term outlook for inflation is lower than three months ago, reflecting weakness in price pressures and falling energy prices.

Oil prices are around 7% lower in the run-up to the August report than in the run-up to the May report.

The Bank reiterated its concerns over the threat of the eurozone crisis to UK growth, and the need for an effective policy response from eurozone finance ministers.

The Bank's assumptions are all based on market expectations of a rate cut to 0.25% in the next year.

But Sir Mervyn said a rate cut was not a move the Bank would "contemplate immediately" as it would damage some financial institutions.

Looking ahead, Monetary Policy Committee member Spencer Dale said the Olympics should have a small positive contribution to the economy in the third quarter between July and September.

He said the lift would come from ticket sales and TV rights, while extra spending from tourism would be offset by travel disruption and Britons leaving the UK for holiday.

Vicky Redwood, chief UK economist at Capital Economics, said: "The door is clearly open to more stimulus and we still expect both more QE and a further interest rate cut in November."

British Chambers of Commerce director general John Longworth said the latest forecast was disappointing and the Government could do more to promote business growth.

He said: "One of the key things the Government and Bank of England need to do is build the business confidence so those businesses which have cash start to invest and grow the economy now."

Mr Longworth said low or negative growth risked the country's market position and demanded long-term infrastructure projects to spark economic activity.

"The Government can now borrow at the lowest (interest) rates ever, so why not take advantage of that?" he told BBC Radio 4's World at One.