For the first time in years, the central bank predicted that
growth would be faster and inflation lower than it expected
three months earlier, though King still warned the recovery
could not be taken for granted.

“Today’s projections are for growth to be a little stronger
and inflation a little weaker than we expected three months ago.
That’s the first time I’ve been able to say that since before
the financial crisis,” King told reporters.

“But this is no time to be complacent. We must press on to
ensure a recovery and to bring down unemployment.”

Sterling rose against the dollar after the forecasts.
British government bond prices extended their losses.

King has presented the BoE’s Quarterly Inflation Report
every three months since the start of 1993, first as the BoE’s
chief economist and since 2003 as governor.

In just over six weeks he will hand the reins to Mark
Carney, who finance minister George Osborne is poaching from
Canada’s central bank in the hope that he will bring new
thinking on how to invigorate Britain’s anaemic recovery.

“We have a team of very good young players and I think with
the right leadership you can look forward to a very successful
future season,” said King, a fan of soccer team Aston Villa
which has just escaped relegation.

However, he remained cautious about what is widely viewed as
Carney’s big idea – offering long-term commitments to keep
interest rates low, so long as certain economic indicators, yet
to be specified, remains within particular bounds.

Osborne has asked Carney to report back on this when he
presents his first inflation report in August. King said the
decision was for the Bank, not the government.

“I think it is very important that those involved, and that
doesn’t include me, will have time now to think through very
carefully what … to do. (This is) the decision of the Monetary
Policy Committee, not that of the Treasury.”

More broadly, King said looser monetary policy would not be
a panacea for Britain’s economic woes. Even the Funding for
Lending Scheme, which King and Osborne launched last year and
expanded last month, would be a modest help, not a game-changer.

“Monetary policy alone … cannot solve all our problems.
There are limits to what can be achieved by general monetary
stimulus – in any form,” he said.

NO MORE QE?

In recent months, King has advocated a resumption of the 375
billion pounds ($572 billion) of government bond purchases that
were a mainstay of BoE policy between March 2009 and October
2012, even as the majority of policymakers opposed it.

He made no mention of more bond buying, or quantitative
easing, on Wednesday, and it is unclear whether he voted again
for it earlier this month.

“QE was notable for its absence,” said Nomura economist
Philip Rush. “That tells us a lot about how the policy debate
has moved in the past few months.”

The inflation report described the BoE’s monetary policy
stance as “highly stimulatory” and said the economy was “likely
to see a modest and sustained recovery over the next three
years”. That was a small upgrade from its assessment in February
that the recovery was likely to be “slow but sustained”.

Britain’s economy grew 0.3 percent in the first three months
of 2013, dodging a new recession. The BoE forecasts 0.5 percent
growth in the second quarter, rising to an annual rate of 2
percent in two years’ time.

But this would still represent Britain’s slowest economic
recovery in decades, and the BoE said GDP was likely to remain
below its pre-crisis level for another year or so.

The central bank also had better news on inflation, in
contrast to three months ago when it shocked markets by
forecasting that it would take until early 2016 before price
growth fell below its 2 percent target.

Now inflation is seen falling to 2 percent in two years’
time from its current level of 2.8 percent.

A strengthening of sterling and lower oil prices have helped
ease price pressures in recent weeks.

Bank of England Governor Mervyn King, presiding over his last Quarterly Inflation Report before he hands the reins to Mark Carney, said the better figures did not mean the recovery was secure.

“Today’s projections are for growth to be a little stronger and inflation a little weaker than we expected three months ago. That’s the first time I’ve been able to say that since before the financial crisis,” King told reporters.

“But this is no time to be complacent. We must press on to ensure a recovery and to bring down unemployment.”

Annual inflation, currently running at 2.8 percent, is likely to fall back to around the bank’s 2.0 percent target in two years’ time. That was lower than a forecast of 2.3 percent the Bank of England made in February.

Sterling rose 0.3 percent against the dollar to hit $1.5272 and British government bond prices extended losses after the cautiously improved forecasts.

A strengthening of sterling and a drop in oil prices have helped ease price pressures in recent weeks.

The bank said the economy was “likely to see a modest and sustained recovery over the next three years.” That represented a small upgrade from its assessment in February, when the bank said the recovery was likely to be “slow but sustained”.

In February, the central bank unsettled some in financial markets by predicting that inflation would not return to target until the first quarter of 2016.

Britain has been suffering its slowest economic recovery in decades, and the BoE forecast that GDP was more likely to remain below its pre-crisis level for another year or so.

Unemployment data on Wednesday underscored how weak Britain’s economy remains.

The number of jobless benefit claimants fell more than expected in April, but a wider international measure of joblessness rose and earnings excluding bonuses grew at their slowest pace since records began in 2001.

Even so, Britain is faring slightly better than some other major European economies. France slipped back into recession in the first quarter of 2013, data showed on Wednesday.

King has led a minority of Bank of England policymakers calling for more bond-buying since February.

The Bank of England generally sets monetary policy with the aim of ensuring that inflation has returned to its 2 percent target within two to three years. Finance minister George Osborne has recently encouraged the bank to take a flexible approach when its next governor takes over.

Carney, who remains governor of the Bank of Canada until June 1 before he moves to London, is also a fan of long-term interest rate guidance to stimulate the economy.

King reiterated that the Bank of England on its own could not fix Britain’s economy: “Monetary policy alone, however, cannot solve all our problems. There are limits to what can be achieved by general monetary stimulus in any form.”

(Writing by William Schomberg; additional reporting by the UK bureau; editing by Jeremy Gaunt and Hugh Lawson)

Former deputy governor Rachel Lomax described the Help-to-Buy initiative as a “short-term political fix” and a “hair of the dog” approach – a reference to treating a hangover with more alcohol.

Finance minister George Osborne announced the scheme in March as a way of helping people on to the property ladder at a time when banks are demanding big down payments.

It allows some buyers to get a mortgage with a deposit of just 5 percent via up to 130 billion pounds of government guarantees on high-risk mortgages for three years.

But it has attracted criticism that it will encourage a return to the risky lending that caused the housing market to overheat in the run-up to the global financial crisis of 2008.

Despite Britain’s weakest economic recovery in decades, the Conservative-led government remains committed to a program of deficit reduction.

With one eye on the public finance pledges it made when it took power in 2010 and another on parliamentary elections due in 2015, it is trying to find ways to boost the flow of credit without adding to government borrowing.

But opponents of the scheme say any growth it engineers will prove unsustainable.

“This is not going to help. This is a short-term political fix,” Lomax said, in unusually outspoken comments.

Lomax, who sat on the central bank’s Monetary Policy Committee from 2003 and 2008, was speaking at a panel discussion on monetary policy issues organized by London-based Fathom Consulting.

Marian Bell, a second former Bank of England policymaker also not known for a sharp tongue, was equally dismissive.

“I really don’t know what Help-to-Buy is trying to achieve,” she said. “No way should they be encouraging risky mortgage lending. If it’s there to boost construction of houses, there are more direct routes to that.”

The government has also committed 3.5 billion pounds in shared equity loans for newly built homes.

The housing schemes complement the government’s Funding for Lending Scheme, which is jointly run with the Bank of England and offers banks big incentives to frontload lending into this year and next.

Fathom, a consultancy run by former Bank of England economists, estimates the combined effect of the schemes could re-ignite a housing market bubble, pushing up property price inflation to almost 20 percent within the next two to three years.

That could generate a feel-good factor in time for the next election but at a cost to Britain’s long-term economic health, said Fathom director Danny Gabay.

(Additional reporting by William Schomberg; Editing by John Stonestreet)

The services sector – which accounts for around
three-quarters of Britain’s economy – grew at its fastest pace
in April since last summer’s Olympics, boosted by the strongest
increase in new orders in almost a year.

Along with recent forecast-beating gross domestic product
data and manufacturing and construction surveys, Friday’s
services reading will ease pressure on the government to water
down its austerity programme, even after a poor showing in local
elections this week.

It also reinforces expectations the Bank of England will
refrain from further stimulus next week, and possibly longer.

A Reuters poll this week showed almost half of economists
now believe there will be no further government bond-buying this
year.

Sterling rose against the dollar on Friday as the rise in
the service sector survey further diminished expectations that
the Bank of England might pump more money into the economy any
time soon.

“Today’s release marks a hat-trick of upside surprises for
April,” said Simon Hayes, UK economist at Barclays. “Recent
activity indicators have had a more encouraging tone and add to
the case for the Monetary Policy Committee holding policy when
it meets next week.”

The Conservative-led government coalition austerity
programme has been under fire for stifling growth and the latest
data may relieve political pressures reflected in poor poll
showings.

The anti-European Union UK Independence Party made big gains
in local elections on Thursday against the conservatives.

The Markit/CIPS services Purchasing Managers’ Index rose to
52.9 in April, its highest reading since August and the fourth
consecutive monthly rise. Economists in a Reuters poll had
expected the index to stay at March’s level of 52.4.

The improvement was broad-based, supported by the strongest
rise in new orders since last May.

Markit’s combined index of services, manufacturing and
construction in Britain rose more than a full point to 52.1 in
April, also the highest since last August.

The figures will be welcomed by the government which, until
last week’s GDP data, feared the country might be slipping into
its third recession in five years. In the event, the data showed
Britain’s economy grew 0.3 percent in the first three months of
this year.

Markit economist Chris Williamson said April’s purchasing
managers’ surveys suggested the return to growth seen in the
first quarter may have gained momentum at the start of the
second.

That prospect should help the government avoid criticism
from the International Monetary Fund draws up its annual health
check of Britain’s economy later this month.

The Financial Policy Committee has operated on an interim
basis since June 2011, and some bankers have criticised its push
for lenders to hold more capital, which they say reduces their
ability to provide credit to British firms and households.

Setting out the first remit for the FPC since it gained
formal powers on April 1, Osborne wrote in a letter to Bank of
England Governor Mervyn King that the body should consider
short-term growth as well as longer-term financial stability.

“It is particularly important, at this stage of the cycle,
that the Committee takes into account, and gives due weight to,
the impact of its actions on the near-term economic recovery,”
Osborne wrote. He said there were “short-term trade-offs”
between sustaining growth and addressing risk.

King has argued that higher capital levels do not reduce
banks’ ability to lend, and instead help the economy by reducing
the risk premium banks pay to borrow and by bolstering general
confidence in the financial system.

Regulators across the world are under pressure to ease tough
new regimes as banks complain they cannot lend to the economy
and build up capital buffers to high levels at the same time.
Earlier this year global regulators gave banks an extra three
years to put in place cash reserves that will help them to
withstand short-term market shocks unaided.

The FPC has already shown some flexibility by allowing
British banks to scale back their very high cash buffers if the
money freed up is lent to businesses and other parts of
Britain’s struggling economy.

But it has not yielded on longer-term capital. Last month it
ordered banks to plug a capital hole of 25 billion pounds ($38.7
billion) by the end of this year, insisting this will be
“manageable” and that the banks that have kept lending were the
best capitalised ones.

The Bank of England said it would make an announcement at
0500 GMT. It gave no further details but sources familiar with
the scheme said it would be extended both in scope and duration.

With little room for manoeuvre on fiscal policy, and central
bankers deadlocked over extending their government bond-buying
scheme, Britain’s government is pinning its hopes on alternative
means of boosting growth.

The original Funding for Lending Scheme was launched last
August and offers banks cheap credit if they increase lending to
households and businesses. Results have been mixed, however,
with benefits so far mainly going to banks and homebuyers rather
than small businesses.

Under Wednesday’s shake-up, the pool of lenders able to
access cheap funding is likely to be extended to include leasing
firms and asset finance groups which are major sources of credit
for small businesses. The deadline for funds to be drawn down
will be extended by a year to 2015, sources said.

Brian Hilliard, UK economist at Societe Generale said it was
a sensible idea to target the funding subsidy at the
institutions closest to small businesses, but that lack of
lending was both a supply and a demand issue.

“Expectations should be modest about what it will do for
growth in the short term,” he said.

Official data shows that banks and building societies drew
down nearly 14 billion pounds under the Funding for Lending
Scheme between August and December. But overall lending fell -
in part because of seasonal factors, and the desire of some
banks to reduce lending to meet tougher capital rules.

The central bank argues that the scheme is a success, and
without it lending would have fallen by much more. Critics claim
there are better ways to support growth, and a bigger response
is needed to counter the deleveraging being undertaken by banks,
households and the public sector.

British government bond prices underperformed German bunds
after the announcement as investors bet a freeing up of credit
would make a further gilt-buying spree from the central bank
less likely.

“Better-targeted policies … naturally means this kind of
credit easing over quantitative easing,” said Nomura economist
Philip Rush.

Non-bank lenders, he said, might be able to make better use
of the scheme since they were less encumbered by bad debts and
onerous capital requirements.

Changes to the scheme have been expected for several days.

Finance minister George Osborne said on Friday he would
announce changes to the scheme “fairly shortly” – in part due to
concerns that its benefits were not reaching small businesses
rapidly. And the trade body for British leasing companies, the
Finance & Leasing Association, told Reuters on Monday it was in
talks with the government about extending the scheme to cover
more firms in the sector.

The fact borrowing fell at all will be some comfort for finance minister George Osborne, after a week when the International Monetary Fund cast doubt on his policies and ratings agency Fitch stripped Britain of its triple-A status.

But Tuesday’s figures from the Office of National Statistics underscore just how far Britain’s Conservative-led coalition has to go to meet its central goal of balancing the public finances, as weak growth saps tax revenue and raises welfare costs.

“There’s a small crumb to be had from the fact that borrowing is less than last year, but really that’s a political point not an economic one,” said David Tinsley, UK economist at BNP Paribas.

“The government seems to be delivering on spending reductions, but it is failing on getting growth … and that’s why the fiscal position isn’t improving. It’s flat-lining.”

The government’s preferred measure of public borrowing – which excludes some effects of bank bailouts and a one-off Royal Mail pension transfer – fell to 114.2 billion pounds ($174.1 billion) in the tax year which ended in March.

This equates to 7.4 percent of economic output, down from 7.9 percent in 2012/13, and is well below a peak of 11.2 percent just before the coalition came to power in May 2010.

But it is still far higher than in most other major advanced economies as Britain struggles to deal with the long-term effects of the financial crisis.

The economy has been broadly stagnant for the past two years, and gross domestic product data on Thursday will show whether the economy has slipped back into technical recession for a third time in less than five years.

Most of the fall in government borrowing was due to a scheme that transferred bond interest previously paid to the Bank of England back to the Treasury. Without this, the deficit would only have fallen to 7.8 percent of GDP.

This year the government aims to cut the deficit to 6.8 percent of GDP, but economists warned even this could be hard, especially as some annual spending that would normally have taken place last year has been pushed into the current year.

“The bigger test will be if he can continue to meet the forecasts for the years ahead, and we think it’s looking vulnerable because of the weakness of the euro area, which could decrease tax revenues and mean higher spending pressures.”

PAIN, NO GAIN?

Deficit reduction is already off course in Britain. In 2010 Osborne announced plans to eliminate Britain’s underlying budget deficit by 2014-15, but this now looks unlikely before 2016-17 at the earliest.

This slippage has been largely due to weak growth, but how much is due to the knock-on effect of turmoil in the euro zone, Britain’s main export market, and how much is down to a bigger-than-expected drag from austerity is disputed.

Last week the IMF – previously a champion of Osborne’s policies – said he may need to rethink the pace of deficit reduction due to the failure of growth to pick up, something the opposition Labour Party has been urging for a long time.

Labour economics spokesman Ed Balls reiterated this criticism on Tuesday, saying that the borrowing figures showed that the government’s policies were “totally self-defeating”.

But the government insisted its policies were working, with the deficit down by one-third since 2010 and 1.25 million new private sector jobs created since then.

Tuesday’s data showed that central government spending in 2012/13 was 1.8 percent up on the year, driven by a 5.6 percent rise in social benefits, which include old-age pensions as well as welfare for those out-of-work. Tax revenue rose 1.8 percent.

Full-year borrowing was in line with forecasts from the government’s budget watchdog last month, though the Office for Budget Responsibility warned that Tuesday’s figures could still face major revisions as they were partly based on estimates.

Data for March alone showed that public borrowing excluding financial sector interventions totalled 15.142 billion pounds, down from 16.694 billion pounds a year ago and just below economists’ forecasts of 15.5 billion pounds.

But the UK Debt Management Office revised up its government bond issuance plans for the coming financial year by 4.7 billion pounds to 155.7 billion pounds, after a volatile cash measure of British borrowing turned out higher than expected in March

And Britain’s total net public debt, excluding the direct costs of bailing out the country’s banks, is still much higher than before the financial crisis at a record 1.1858 trillion pounds or 75.4 percent of GDP.

($1 = 0.6560 British pounds)

(Additional reporting by Paul Sandle; editing by Catherine Evans, Ron Askew)

The Office for National Statistics said public borrowing, excluding some effects of bank bailouts and a one-off Royal Mail pension transfer, was 114.2 billion pounds in the 2012-13 tax year, equivalent to 7.37 percent of national output.

This was down from 120.9 billion pounds or 7.93 percent of output in 2011/12, and in line with the forecast last month by Britain’s budget watchdog, the Office for Budget Responsibility.

A tougher measure of borrowing – which in addition strips out cash transfers from the Bank of England allowed under European Union statistical rules – also fell marginally on the year.

Nonetheless, Britain’s budget deficit is still one of the highest among major advanced economies as the country struggles to deal with the legacy of the financial crisis.

“The Chancellor just made it in under the OBR’s forecast, albeit by the skin of his teeth,” said Victoria Clarke, an economist at Investec.

“The bigger test will be if he can continue to meet the forecasts for the years ahead, and we think it’s looking vulnerable because of the weakness of the euro area, which could decrease tax revenues and mean higher spending pressures.”

The government welcomed the data as a sign that its policies were working. “Though it is taking time, the government is fixing this country’s economic problems,” the Treasury said in a statement, citing a one-third reduction in the budget deficit since 2010 and the creation of a million-and-a-quarter new private sector jobs.

There was little immediate market reaction to the data, with many investors more focused on first-quarter gross domestic product data due on Thursday, which will show whether the economy has slipped back into recession.

The figures follow a difficult seven days for finance minister George Osborne. His Conservative-led coalition’s flagship austerity policy has come under increased scrutiny from the International Monetary Fund, and a second major ratings agency has stripped Britain of its triple-A status.

The IMF – previously a supporter of Osborne’s tough approach – has said that weak growth means he may need to rethink the pace of deficit reduction, something the opposition Labour Party has been urging for a long time.

Osborne is already off track on his deficit reduction plan, compared to what he intended when he became finance minister in May 2010. He originally aimed to eliminate Britain’s underlying budget deficit by 2014-15, something which now looks unlikely before 2016-17.

This slippage has been largely due to weak economic growth which has hurt tax revenues and pushed up benefits spending.

How much of this weak growth is due to the knock-on effect of turmoil in the euro zone, Britain’s main export market, and how much is down to a bigger-than-expected drag from austerity is disputed.

Data for March alone showed that public borrowing excluding financial sector interventions totaled 15.142 billion pounds, down from 16.694 billion pounds a year ago and just below economists’ forecasts of 15.5 billion pounds.

But the UK Debt Management Office revised up its government bond issuance plans for the coming financial year by 4.7 billion pounds to 155.7 billion pounds, after a volatile cash measure of British borrowing turned out higher than expected in March

Britain’s total net public debt, excluding the direct costs of bailing out the country’s banks, is still much higher than before the financial crisis at a record 1.1858 trillion pounds or 75.4 percent of GDP.

(Editing by Catherine Evans)

The move is an embarrassment for Britain’s Conservative-led
government which promised to protect the country’s rating when
it took power in 2010, and will heighten the debate about
whether austerity is still the right approach.

Fitch trimmed the rating to AA-plus from AAA, citing a
weaker economic and fiscal outlook. But it returned the outlook
to “stable”, removing the threat of any further rating action,
at least in the near term.

“The fiscal space to absorb further adverse economic and
financial shocks is no longer consistent with a ‘AAA’ rating,”
it said in a statement.

Economic stagnation has pushed the government’s deficit
reduction programme several years off track, leading critics to
argue the government should focus less on the deficit and more
on growth. Even the International Monetary Fund, once a key ally
in the case for fiscal austerity, has urged Britain to consider
slowing the pace of deficit cuts.

But although sterling fell in the immediate aftermath,
analysts said the downgrade was likely to have limited impact on
debt markets or the government’s economic policy.

“The downgrade only tells us what was already known: that
fiscal consolidation has ground to a halt and that the growth
outlook is poor,” said Rob Wood, UK economist at Berenberg Bank.

Moody’s was the first agency to downgrade Britain in
February and Standard & Poor’s has said there is at least a
one-in-three chance it will follow suit.

AUSTERITY RIFT WIDENS

Britain’s finance ministry said that Fitch’s decision
reinforced the need for the country to cut its deficit.

“This is a stark reminder that the UK cannot simply run away
from its problems, or refuse to deal with a legacy of debt built
up over a decade,” a spokesman said.

However, the opposition Labour Party said Osborne should
change course.

“This is another humiliating blow to a Prime Minister and
Chancellor who said keeping our AAA rating was the number one
test of their economic and political credibility,” said Ed
Balls, Labour’s finance spokesman.

Fitch analyst David Riley told Reuters that Britain could be
downgraded again if the economy failed to pick up as forecast,
or debt stayed higher for longer than they expected.

But he did not say the answer was to ease back on austerity.

“The current pace of deficit reduction doesn’t seem
excessive,” Riley said. “Other countries in Europe are cutting
at a similar speed or even faster.”

Finance minister George Osborne admitted last month that
growth this year would be half the level previously assumed and
public debt would rise for several more years.

Nonetheless, gilt prices remain near record highs, and
France and the United States have both been stripped of their
triple-A rating by more than one agency without any major loss
of investor confidence.

“If anybody is completely surprised by this, I think they
have been hibernating,” said Peter Schaffrik, Head of European
Interest Rate Strategy at Royal Bank of Canada.

The Markit/CIPS manufacturing purchasing managers’ index came in at 48.3, only slightly above February’s surprisingly poor reading of 47.9, and a touch weaker than the consensus forecast.

The output component of the survey fell in March at its fastest pace since October. There were signs of weakness in the key housing market too.

While lending to Britain’s consumers ticked up in February, the number of mortgage approvals for house purchases fell for a second month, Bank of England data showed. Nonetheless, the value of home-backed lending rose.

But there was better news from the country’s largest business survey which showed that export orders with British firms rose strongly in the first three months of 2013 and confidence about the next 12 months picked up.

The Markit PMI survey suggests that manufacturing exerted an even bigger drag on growth between January and March than it did in the fourth quarter of 2012, when it accounted for a third of the economy’s 0.3 percent contraction.

“The onus is now on the far larger service sector to prevent the UK from slipping into a triple-dip recession,” said Rob Dobson, senior economist at Markit.

Official GDP data for the first quarter won’t be released until April 25 but the evidence so far suggests a strong risk that Britain will record a second consecutive quarter of contraction – the technical definition of recession.

A third recession in less than five years would be an embarrassment for the government which is sticking to tough austerity measures.

“All this still points to a very subdued economy, which will keep the pressure on the BoE to do more to offset the UK’s tight fiscal stance,” said James Knightley, an economist with ING, referring to Tuesday’s data. “However, our central case remains for a no-change decision this week.”

The Bank of England’s policymakers meet on Wednesday and Thursday. More action, possibly in the form of renewed government bond-buying or quantitative easing, is only expected later this year.

“We don’t think that that is going to be sufficient to push the (bank) into the sanctioning QE as soon as this week,” said Philip Shaw, an economist with Investec. “But nonetheless, the committee can’t be altogether happy with some of these indicators which have shown the economy remaining in uncertain mode.”

The Markit report blamed the poor performance of manufacturing in March on tough market conditions, subdued client confidence and ongoing bad weather.

New orders from abroad contracted for the 15th month running in March. The survey blamed the fall on weak demand from Europe and strong competition in U.S. and South Asian markets.

In further bad news for UK policymakers, there were also signs that inflation pressures were picking up. Output prices rose at the fastest pace in three months while input prices picked up sharply, driven by the weakness of sterling and higher energy and food costs.

Manufacturing accounts for around a fifth of British economic output. Surveys of the construction and service sectors for March are due to be released on Wednesday and Thursday respectively.

There have been signs that the services sector is faring better than manufacturing. It grew at its fastest pace in five months in February, according to Markit and official data showed it notched up its best performance in January for five months.

(Additional reporting by Olesya Dmitracova, Oxana Andrienko and Li-mei Hoang. Editing by Jeremy Gaunt.)