LONDON Britain should enjoy solid growth if Brexit goes smoothly, but in the short run households are likely to be hit by inflation prompted by the decision to leave the European Union, the Bank of England said on Thursday.
Governor Mark Carney, speaking a month before a national election, said the economy was still growing and employing a record number of people, playing down recent signs of weakness.
Britain's economy was one of the best performing major advanced economies last year, wrongfooting the BoE and most other forecasters who predicted that voting to leave the EU would send the economy into a tailspin.
The Bank's two previous sets of quarterly forecasts brought big upward revisions to the growth outlook and on Thursday it only softened its short-term outlook a fraction, despite recent data showing that growth is now slowing sharply.
It trimmed its forecast for growth this year to 1.9 percent from 2.0 percent, but nudged up forecasts for 2018 and 2019 to 1.7 percent and 1.8 percent. Last year Britain's economy grew 1.8 percent.
The forecast hinged on a "smooth" transition to Brexit, as well as a big pick-up in wage growth and stronger exports and investment -- things the central bank has predicted before, but which have largely not materialised.
Carney said the BoE had not tried to forecast what would happen if there was a "disorderly Brexit" where Britain crashes out of the EU without an agreement on future trade relations.
While not visibly concerned about the economic outlook, Carney did say that sterling weakness caused by the Brexit vote left British consumers with less spare cash.
"This is going to be a more challenging time for British households," Carney told a news conference, highlighting that inflation would peak at nearly 3 percent this year.
Economic growth slowed to just 0.3 percent in the first quarter, less than half its rate at the end of 2016. While the BoE expects this to be revised up, official data earlier on Thursday showed industrial output was in fact weaker than originally thought.
"There's a lot resting on the assumption that the sustainability of growth and pick-up in wages will be aided by a smooth Brexit," said Tim Graf, head of European macro strategy at State Street Global Markets.
"It doesn't take much for the uncertainty around Brexit to (lead to) lower investment and a weaker labour market."
RATES ON HOLD UNTIL 2019
The BoE said it could only do so much to offset a Brexit hit to the economy, and Carney said the two-year process of leaving the EU did not mean its hands were tied over monetary policy.
"Monetary policy could need to be tightened by a somewhat greater extent over the forecast horizon than the very gently rising path implied by the market yield curve at the time of the forecast," Carney said.
This could mean a rate rise around the time Britain leaves the EU at the end of March 2019.
The financial market instruments which the BoE uses to construct its economic forecasts fully priced in an interest rate rise only in the final three months of 2019, nine months later than in the last set of forecasts in February.
But these market assumptions were based on average prices in the two weeks to May 3. Since then, markets have moved to price an earlier rate hike by the BoE and sterling has strengthened, which should help to push down on inflation.
The BoE also said on Thursday that its Monetary Policy Committee (MPC) voted 7-1 in favour of keeping rates on hold at their record low 0.25 percent, as expected in a Reuters poll.
U.S. academic Kristin Forbes, who leaves the MPC at the end of June, again voted to raise rates to 0.5 percent. It would not take much news on increased growth and inflation for some other policymakers to join Forbes, the BoE said, echoing language from March's meeting.
Sterling slipped after the Bank's announcement, which some investors had expected to show a deeper split among policymakers about the need for higher interest rates now.
The BoE said inflation was likely to fall back to 2.16 percent in just over two years' time - still above the BoE's target - and then pick up slightly going into 2020. Usually BoE inflation forecasts show inflation falling back to target.
Wage growth - which has been weak in Britain since the financial crisis - is forecast to pick up to 3.5 percent next year from around 2 percent at present as businesses find it harder to recruit staff.
(Additional reporting by Jamie McGeever Editing by Jeremy Gaunt)