Bank's cautious view hints at low rates until next year

Mervyn King predicts a gradual recovery of the British economy
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The Independent Online

The Governor of the Bank of England, Mervyn King, has said that the British economy is continuing to "bump along the bottom".

In a cautious quarterly Inflation Report, Mr King was keen to stress that the option of resuming quantitative easing (QE) – injecting money directly into the economy – remains open, although the £200bn is now complete. The doveish tone of the report convinced many City economists that interest rates will still be below 1 per cent by the end of this year, against 0.5 per cent now, a record low.

"Although the MPC last week announced a pause in its programme of asset purchases, it is far too soon to conclude that no more purchases will be needed. So the Committee will keep its options open, and further purchases will be made if they prove necessary," said Mr King.

He agreed that a quarter of negative growth this year – the so-called "double dip" – is consistent with his forecasts. "Our central view is for a gradual recovery but around that there are many risks," he said.

He rejected the idea, suggested by the Conservative leader, David Cameron, that the UK's public finances were in as poor a state as those in Greece: "I don't think you can compare the UK with Greece. There are big differences. We have our own currency. There is clear political consensus to take action here. There is a good track record ... and perhaps, more importantly, the maturity of UK debt is much longer."

The economy is now expected to grow by about 1.5 per cent in 2010, compared with the 2.2 per cent expansion envisaged by the Bank in November. The Bank thinks UK growth will accelerate to more than 3 per cent by the end of this year – higher than many other independent forecasts.

Fresh numbers from the Office for National Statistics (ONS) show that manufacturing grew by 0.9 per cent last month, making an upward revision to growth very likely. The National Institute of Economic and Social Research have estimated growth of 0.4 per cent in the three months to January, reinforcing that optimistic view.

Inflation, meanwhile, will soon reach 3.5 per cent, having already risen to 2.9 per cent on the CPI measure in December "reflecting higher petrol price inflation and last year's temporary reduction in VAT dropping out of the 12-month comparison". Longer term, the Bank says inflation will settle at about 1.2 per cent in two years' time, and about 1.6 per cent in three years' time.

Bank officials were disappointed the sluggish response of exports to the 25 per cent depreciation in sterling since 2007. The deputy governor for monetary policy, Charles Bean, citing historical experience such as sterling's 1992 exit from the European exchange rate mechanism, expressed some confidence that the effects of sterling's depreciation would feed though to growth over the next few years. Mr King added that the beneficial effects of the QE policy have also not yet been fully felt.

Mr King offered little hope to the Council of Mortgage Lenders and others calling for an extension of the Bank's assistance. He said of the Special Liquidity Scheme: "We certainly have no intention of extending it. It is the most generous scheme in the world.

"We are working with the FSA and individual banks to ensure they have schedules for refunding this money. Banks should be willing to issue longer-term debt securities rather than rely on shorter-term instruments. That means in the longer term banking will be less profitable but I think this is an inevitable result of this crisis."

Forecasts: Highs and lows

The Bank prefers to present its economic forecasts not as "point" projections, but in the form of a range of possibilities, the "fan chart", which can be so wide as to be almost meaningless.

Such were the uncertainties surrounding the economy last year that the range spanned mild recession to deep, 1930s-style slump.

The range of possible outcomes has since narrowed slightly, and the Bank's view of growth next year is firmly in the pack of independent bodies here and abroad, from City economists to the IMF.

The Treasury regularly surveys the independent forecasters: the current average for 28 bodies is 1.4 per cent growth in 2010.

Next year, though, the Bank is out on the optimistic end of the spectrum, in the 3 to 3.5 per cent range. This is near to the Treasury's forecasts, but most City economists and the IMF would lop about 1 percentage point from that forecast.

The National Institute of Economic and Social Research said yesterday that the economy contracted slightly in January, perhaps as a result of the hike in VAT, but that the quarter to the end of that month saw a spurt in growth to 0.4 per cent, or 1.6 per cent annualised.

Alastair Marsh