The U.K.'s economy will continue to improve, but the Bank of England faces a "big challenge" to maintain that recovery while simultaneously ending its monetary stimulus program, according to the latest report from Pricewaterhouse Coopers (PwC).
PwC, a global professional services firm, warned in its "U.K. Economic Outlook" report that inflation would remain "stubbornly" above target during this year and next, presenting a dilemma for the Bank of England and subduing real earnings growth for the next five years.
"In the longer-term, the big challenge facing [central bank Governor] Mark Carney will be to negotiate a safe exit from current very loose monetary conditions, without either crushing the recovery or losing control of inflation. This will be a difficult balancing act to pull off," said the report's main authors, John Hawksworth, Jonathan Bruce and Smita Mehta.
"We are not at that point in the recovery yet in the U.K., but we could get there during the next year or two," they added.
The authors said that Gilt yields looked "unsustainably low", and forecast the yield on 10-year benchmark Gilts would rise to between 4.0 and 5.5 percent by 2025. "Recent yields look unsustainably low in the longer-term, given that quantitative easing is expected to unwind gradually over the next decade or so, and investor attitudes to risk should eventually return to more normal levels," they said.
PwC forecast the U.K. would grow by 1 percent in 2013 and 2 percent in 2014, roughly in line with this week's revised forecasts from the International Monetary Fund .
"Services will remain the main engine of growth, but we also expect a gradual recovery in manufacturing and construction over the next 18 months," Hawksworth, Bruce and Mehta said. They also predicted that employment and investment would rise, and that there would be a recovery in housebuilding.
"In cash terms, average U.K. house prices might be back to their 2007 peak level by the end of 2014, although in real inflation-adjusted terms this might not happen until 2021. The government's recent initiatives to support the mortgage market should help to boost house prices in the short-term, but the longer-term priority should be to boost housing supply," they said. U.K. house prices have fallen around 18 percent in real terms since their peak in the third quarter of 2007.
The report also offered some words of caution regarding the country's reliance on the euro zone for trade.
"Risks are still somewhat weighted to the downside, due to the possibility of further adverse shocks in the euro zone that could puncture fragile confidence at home, and lead to a renewed recession (or at least stagnation).," PwC warned. "But there are also upside possibilities, if these problems can be avoided, and a virtuous circle of rising confidence and spending can be established, as in past economic recoveries."