By Olesya Dmitracova and Shadia Nasralla
LONDON (Reuters) - The Bank of England's chief economist warned against "dangerous talk" of tolerating higher inflation, days before the Chancellor is expected to pave the way for the bank to take a more active approach to boosting growth.
With the government pledging to persevere with its austerity drive, attention has turned to whether Britain's central bank will be given greater scope to stimulate an economy on the verge of another recession.
However, Spencer Dale noted "worrying" signs of "a sense that inflation is somehow yesterday's war. That central banks should focus more on growth. That a period of higher inflation may even aid the recovery".
"This is dangerous talk," Dale said in a speech at the central bank on Friday.
Chancellor George Osborne is expected to announce a review of the Bank's inflation-focused remit, or outright changes to it, when he presents his annual budget on Wednesday.
"We will continue to wait for the government to make a decision on the remit," Dale said in a question-and-answer session after the speech.
Bank of Canada Governor Mark Carney, who takes over the Bank of England in July, wants to examine the remit and his appointment triggered a substantial debate both inside and outside the bank over possible options.
Dale said there were aspects of the current framework that worked well, but signalled his openness to improvements of the remit, currently focused on keeping inflation at two percent.
However, he sounded wary about a major change that might damage the bank's inflation-fighting credibility.
Possible changes include explicitly giving the Bank more time to bring inflation under control or, more radically, instructing the bank to also pursue an employment target, similar to the U.S. Federal Reserve's dual mandate.
Analysts note the Bank is already flexible in the way it implements its inflation remit, having failed to meet the 2 percent target for more than three years.
"We will hit the inflation target. And if we don't hit the inflation target over time, the cost to our economy will be very severe," Dale said.
LENDING SCHEME ON TRACK
Dale has been the most reluctant among the current Bank policymakers to back more monetary stimulus and his latest comments make it unlikely he changed his mind at a policy meeting this month, when the Bank voted against extending its asset purchase programme.
Last month BoE Governor Mervyn King and fellow policymaker Paul Fisher unexpectedly joined David Miles in calling for a top-up.
On Friday, Dale raised doubts over some of the prevailing explanations of Britain's unusually weak productivity in recent years, and said the financial crisis probably played a key part.
"It seems particularly optimistic to assume that...the near crippling of our banking system has played little role in the recent limp supply-side performance of our economy," he said.
Dale also said the Bank's Funding for Lending Scheme, which provides cheap funding to banks to encourage them to lend to businesses and households, had so far performed as he had expected.
Small and medium-sized firms are yet to benefit substantially from the scheme and business minister Vince Cable has called for changes to make the FLS more suitable for them.
In the minutes to the Bank's February meeting, policymakers suggested that new measures to spur lending were needed.
A record of this month's meeting, to be released on Wednesday, will show whether Dale again opposed increasing the Bank's asset purchase target beyond 375 billion pounds reached in October.
(Additional reporting by Christina Fincher and David Milliken)