The recovery continued in the United Kingdom, with output growth across the first half of 2010 close to its historical average. But the level of economic activity remained well below its pre-crisis peak. The revival in the world economy also proceeded, albeit unevenly. The UK recovery is likely to continue, underpinned by the considerable monetary stimulus, further growth in global demand and the past depreciation of sterling. But the risks to growth remain weighted to the downside. Spare capacity is likely to persist over the forecast period, although its extent will depend on the strength of demand and the evolution of supply, both of which are uncertain.

CPI inflation remained well above the 2% target, elevated by temporary effects stemming from higher oil prices, the restoration of the standard rate of VAT to 17.5% and the past depreciation of sterling. And the forthcoming increase in the standard rate of VAT to 20% will add to inflation throughout 2011. As these effects wane, downward pressure on wages and prices from the persistent margin of spare capacity is likely to pull inflation below the target. But the pace and extent of that moderation in inflation are impossible to predict precisely. Under the assumptions that Bank Rate moves in line with market rates and the stock of purchased assets financed by the issuance of central bank reserves remains at £200 billion, inflation is a little more likely to be below the target than above it during the second half of the forecast period, although those risks are broadly balanced by the end.

Financial and credit markets

Since the May Report, the MPC has held Bank Rate at 0.5% and maintained its stock of purchased assets at £200 billion. Financial market conditions remained strained, although they eased a little following publication of the results of the CEBS stress tests on EU banks. Market participants revised down further their expectations of the near-term path of Bank Rate. Ten-year gilt yields fell, as did equity prices, while corporate bond spreads widened. The sterling effective exchange rate rose.

UK banks continue to face a number of challenges related in particular to their need to refinance substantial levels of maturing funding. Credit conditions improved a touch, though less so than earlier in the year, while the stock of bank lending to companies fell further. Annual broad money growth remained weak.

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