By David Milliken and William Schomberg
LONDON (Reuters) - The Bank of England cut its forecasts for British economic growth over the next three years on Wednesday, and cautiously backed bets in financial markets that it will only start to raise interest rates in around a year's time.
The central bank now expects growth this year of 2.5 percent, down from a 2.9 percent projection in February and closer to most other economic forecasters' expectations.
Britain was the fastest-growing major advanced economy in 2014, as it made up ground lost during the financial crisis, but the recovery has slowed since the start of this year.
The Bank said its growth downgrade was because interest rates were likely to increase slightly faster than markets had expected three months ago, sterling had strengthened and the outlook for house-building and productivity had weakened.
Boosting Britain's dismal productivity performance since the financial crisis is the biggest economic challenge facing Prime Minister David Cameron after he won a second term of office last week, and one over which the Bank has little sway.
"Productivity ... is not something that monetary policy determines, and ... the timing and extent of any prospective pick-up in productivity growth remains our most difficult judgement," BoE Governor Mark Carney said on Wednesday as the Bank published its quarterly Inflation Report.
The Bank said a jump in low-paid jobs had dampened wage and productivity growth but this would lift as new hiring ebbs.
Sterling
BNP Paribas (PARIS:BNPP) economist Dominic Bryant said the Bank was in a holding operation. "The Bank seems in no hurry to raise rates this year, while next year is sufficiently far away that it does not feel the need to micro-manage expectations," he said.
GRADUAL RATE RISES
After suggesting in April that markets were too relaxed about the timing of a rate hike, policymakers appeared happier and said the market pricing was consistent with inflation hitting its 2 percent target within two years.
The Bank's forecasts are based on market pricing it will start to raise rates from their record-low 0.5 percent in the second quarter of next year -- three months earlier than expected in February -- and approach 1 percent by late 2016.
Policymakers remained concerned that bond markets only appeared to be prepared for very small increases in global interest rates in the longer term.
Global bond yields have jumped since the MPC's meeting last week, as investors respond to rising oil prices and the increasing likelihood of U.S. interest rates rising.
The Bank has kept rates unchanged for more than six years. It warned markets a year ago that they could rise sooner than expected but then oil prices tumbled and took inflation to a record-low of zero.
Carney reiterated that inflation was likely to turn negative over the next few months before recovering next year.
The Bank lowered projections for British economic growth in 2016 and 2017 to 2.6 percent and 2.4 percent respectively and could slow further if the crisis Greece intensified.
It also cut its forecast for wages which it saw rising by 2.5 percent by the end of 2015, down from its February forecast of 3.5 percent growth, before picking up to 4 percent in 2016.
Figures released earlier on Wednesday showed wages rose by an annual 1.9 percent in the first quarter and the jobless rate dropped to a near seven-year low of 5.5 percent.