By David Milliken and William Schomberg
LONDON (Reuters) - The Bank of England scrapped its plan to cut interest rates, which it said could now move up or down, and raised its forecasts for 2017 growth and inflation sharply due to the slide in sterling since Britain's vote to leave the EU.
The battered pound rose and British government bond prices fell after the BoE shifted to what Governor Mark Carney called "a neutral stance" on what its next move would be.
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The Bank, which has faced political criticism for its near-zero rates, rethought its view on when Britain's economy will feel the pain of June's decision to leave the European Union.
In a set of forecasts on Thursday, it largely reversed its previous prediction of a major hit to growth next year which it now saw at 1.4 percent, up from an estimate of 0.8 percent made in August. That represented its biggest ever growth upgrade.
But it warned that Britain's access to EU markets could be "materially reduced", which would hurt growth over "a protracted period" and forecast a slower recovery for 2018 and 2019 as significantly above-target inflation squeezed living standards.
The BoE responded to the Brexit vote by cutting rates to a record low of 0.25 percent in August and reviving its bond-buying plan. It also said then that another rate cut was likely in 2016 if the economy slowed as it expected.
Critics, many of them Brexit supporters, accused Carney and his fellow policymakers of overstating the risks to the economy.
Asked by reporters about the big change to the 2017 growth forecast, Carney said in "broad-brush" terms the BoE was sticking to its view of the economy in three years' time.
The BoE's nine policymakers all voted to keep rates on hold, in line with a Reuters poll of economists. There was also unanimous support to stick with August's bond-buying plans.
RECORD INFLATION OVERSHOOT
The Bank said it now expected a record overshoot of inflation above its target over the next two to three years, peaking above 2.8 percent in early 2018, because of sterling's recent fall to a 31-year low against the U.S. dollar.
"There are limits to the extent to which above-target inflation can be tolerated," the BoE's Monetary Policy Committee said as it forecast inflation would jump to 2.7 percent this time next year, nearly triple its current level.
"Monetary policy can respond, in either direction, to changes in the economic outlook as they unfold to ensure a sustainable return of inflation to the 2 percent target."
Inflation was only expected to return to 2 percent in 2020.
But economists doubted the Bank would raise rates soon. "We don't think there is any material probability of a Bank Rate hike in the foreseeable future," RBC's Sam Hill said.
Thursday's change in stance could please Prime Minister Theresa May, who said last month that the BoE's ultra-loose monetary policy had "bad side effects" for savers and had to change, raising questions about the BoE's independence.
Soon after, Carney said he would not "take instruction" from politicians on how to meet the Bank's inflation target.
Earlier this week, the Canadian said he would stay at the BoE for an extra year until June 2019 but declined to take up an option of staying until 2021.
Carney sought to return the focus to the Bank's monetary policy on Thursday, saying he wanted to move on from the "saga" around his position and denying that the BoE had come under political pressure from Downing Street.
But he declined to answer questions about whether he might stay on at the Bank longer than 2019.
Sterling's renewed fall last month came shortly after May suggested she might adopt a tough approach for Brexit talks with the EU, pushing the currency down to around $1.22.
It jumped above $1.24 on Thursday after England's High Court ruled that the government needs parliamentary approval to trigger Brexit. Carney cited the ruling as an example of uncertainty that could affect the economy.
Sterling rose further to nearly $1.25 after the BoE announcement.
The BoE said it would keep a close eye on inflation expectations and that its response to a further inflation overshoot would hinge on the reasons behind it, how widespread price rises were and the size of any shortfall in growth.
While the BoE raised its growth forecast for 2017, it revised down its 2018 growth forecast to 1.5 percent and saw growth of 1.6 percent in 2019.
(Additional reporting by Sarah Young; Writing by David Milliken and William Schomberg; Editing by Catherine Evans and Hugh Lawson)