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Bank of England Offers Ray of Hope for UK Economy

Chris Ratcliffe | Bloomberg | Getty Images

The Bank of England bucked the trend of its recent forecasts on Wednesday by modestly upgrading its growth outlook and penciling in a faster fall in inflation.

In its quarterly economic update, the central bank gave no sign that it was on the verge doing more stimulus, describing policy as "highly stimulatory", but noted that risks to recovery remained to the downside.

"The economy is likely to see a modest and sustained recovery over the next three years," the central bank said, though it added that the recovery would "remain weak by historical standards".

(Read more:Bank of England Holds Back on New Stimulus)

This represents a cheerier outlook than in February, when the bank said the recovery was likely to be "slow but sustained".

Britain has been suffering its slowest economic recovery in decades, and the BoE forecast that GDP was more likely than not to remain below its pre-crisis level for another year or so.

"The main risks to the recovery continue to emanate from abroad," the BoE said.

Figures earlier on Wednesday showed that France's economy shrank in the first three months of 2013, and weak demand in the euro zone as a whole has been a major headwind for Britain's exporters in recent years.

(Read more: Le Big Debate: France Triple-Dip or Not?)

The central bank forecast that inflation in two years' time is likely to be around its 2.0 percent target - down from the 2.3 percent which it forecast in February - and that inflation would average below 2 percent for the rest of the forecast period.

Inflation has exceeded the central bank's 2 percent target since December 2009, and its persistent failure to return to target is one reason why the BoE has not increased bond purchases past the 375 billion pounds reached in October.

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, and finance minister George Osborne has recently encouraged the bank to take a flexible approach.

Incoming bank governor Mark Carney - who takes over from Mervyn King in July - is also a fan of long-term interest rate guidance to stimulate the economy.

(Read more: UK Looking Good in 'New Normal': Ex-BoE Official)

In recent months the BoE has shifted its focus away from bond purchases - the main tool it has used since March 2009 once it had slashed rates to a record low of 0.5 percent.

The bank stopped buying bonds in October, and last month it expanded its Funding for Lending Scheme, which started in August, to give banks greater incentives to lend to business.

Economists had widely expected the BoE to revise down its inflation forecast due to a strengthening in sterling and a fall in commodity prices since February.

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