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LONDON, Feb 24 (Reuters) - The British economy probably needs yet more stimulus to head off the risk of deflation, and increasing the money supply may be the way to go, Bank of England policymaker Andrew Sentance said on Tuesday. The normally hawkish Monetary Policy Committee member said there was still a risk of inflation undershooting the target in 2-3 years time, even with a huge boost to the economy in place from big cuts in interest rates and a competitive pound.
"If the recession is prolonged and deep, there is an increased risk of deflation," he said, according to the text of his remarks.
"A persistent and prolonged period of deflation still remains an outside risk, in my view. But there is a strong case for providing additional stimulus to the economy to head it off more decisively, as well as helping to limit the potential long-term damage to the UK's supply capacity from a prolonged and deep recession."
He said that as interest rates were close to zero -- the central bank cut them to a record low of 1 percent this month -- further stimulus would probably mean deploying quantitative easing, otherwise known as boosting the money supply.
But he admitted that such a move -- practised with limited success in Japan in the early part of this decade -- was a "step into the unknown".
The Monetary Policy Committee unanimously voted to seek permission from the Treasury to start a process of buying either gilts or other securities with newly-created money. The terms under which they may operate are expected this week.
Sentance noted that the BoE's latest forecasts suggested the economy would bottom out towards the middle of this year and that if this were to happen, there would be an improvement in confidence measures in the CBI and other business surveys.
"Continued extreme weakness of business confidence into the second half of this year would be a signal that the recession was going to be more prolonged and possibly deeper than previous downturns," he said.
Sentance said that it would take some time for the rate cuts of the last few months to make their full effect on the economy, so it was too early to say how much they would support consumer spending.
But the boost to disposable income from lower energy prices should help support the turnaround. "In addition to the impact of lower interest rates on domestic demand, growth in the UK economy should receive additional support over the course of this year from a competitive pound," he said.