British inflation will be below target in two years time if interest rates rise gradually from the middle of next year as financial markets expect, the Bank of England said in its quarterly Inflation Report on Wednesday.
However, overall the Monetary Policy Committee saw broadly balanced risks of inflation being above or below their 2 per cent target by late 2011, suggesting little immediate need for more quantitative easing.
"A recovery in output is likely, driven by the considerable stimulus from the past easing in monetary and fiscal policy and the depreciation of sterling," the BoE said.
"But constraints on the supply of bank credit and concerns over balance sheets will weigh on spending."
The Bank of England slashed rates last year after Britain entered its sharpest recession in decades, and since March has held interest rates at a record low of 0.5 per cent and announced 200 billion pounds of asset purchases with newly-created money.
Charts in the BoE report showed that the central bank expects inflation to rise sharply to above 2 per cent in the next few months -- higher than forecast in August -- before easing back to around 1.6 per cent in the medium term.
Those forecasts are based on financial market assumptions of interest rates averaging 0.6 per cent in the second quarter of 2010, rising steadily to 2.9 per cent in Q3 2011.
"The risks of inflation being above or below target are broadly balanced by the end of the forecast period. But there are significant risks to the inflation outlook in each direction," the Bank said.
This assessment could suggest that last week's announcement of an expansion to the central bank's quantitative easing programme could be the last, although the Bank has scope to change its view before the 200 billion pounds of funds are spent by next February.
BoE projections show growth returning at the beginning of 2010, similar to August's forecasts, but then increasing slightly more rapidly than previously forecast to around 3.75 per cent at the end of 2011.
The level of GDP is seen returning to its pre-recession peak at the beginning of 2011.