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BOE predicts inflation will worsen

Danica Kirka, Associated Press

LONDON (AP) -- The Bank of England predicted Wednesday that the inflation rate may hit 3 percent by summer — but pledged to tolerate the increase in an attempt to help the economy recover.

Bank of England Governor Mervyn King said inflation would be above the 2 percent target for another two years, but that there is cause for optimism and that an economic recovery is in sight. He told reporters the bank would look past inflation figures to support growth and employment.

"Although output has been broadly flat for the past two years, that masks a more encouraging underlying picture," King told reporters at a news conference. "The bulk of the economy - primarily the services and manufacturing sectors together - actually grew at the steady, if unspectacular, rate of 1.2 percent over 2012."

King cautioned, however, that the recovery would not be smooth. Uncertainty about the solvency of banks has led to a reduction in credit, and expectations about future income have reduced demand at home, the bank said in its report.

"This hasn't been a normal recession, and it won't be a normal recovery," King said. "Our economy faces big challenges stemming from an abrupt and substantial reassessment of future economic prospects triggered by the financial crisis."

Vicky Redwood, the chief UK economist at Capital Economics, said King's willingness to look past the "temporary albeit protracted" period of high inflation means he's adopting the flexible approach to inflation that incoming governor Mark Carney recently advocated.

Unlike the Federal Reserve, which aims to control inflation and also increase employment, the Bank of England's exclusive mission has been to keep inflation close to 2 percent. However, a "flexible" approach allows it to overlook temporary increases or drops in inflation to allow the economy to recover. Raising interest rates to lower inflation would hurt the recovery.

The Bank of England, which was granted independence of the government in 1997, has had to adopt this more flexible approach in recent years because inflation has remained stubbornly above target since the financial crisis started in 2007 — even though the economy has fallen into recession twice.

According to the latest measures, inflation was 2.7 percent in January.