King warns of imbalances in economy

Mervyn King, the deputy governor of the Bank of England, warned last night that imbalances within the domestic economy ran the risk of causing a "large negative demand shock" some time in the future.

"Beneath the surface of overall stability in the UK economy lies a remarkable imbalance between a buoyant consumer and housing sector, on the one hand, and weak external demand, on the other...," Mr King said.

"Even the optimistic Mr Micawber would realise that this cannot continue indefinitely," he said in a speech to the London School of Economics.

Concerns over the sluggish global economy were overshadowed by rising house prices which have raised fears of a slowdown on a scale last seen in the early 1990s.

While there were "justifiable concerns" over recent movements in asset prices – ranging from sliding share prices to booming house prices and sterling's ongoing strength – Mr King said it was virtually impossible for the Bank's Monetary Policy Committee to target asset prices.

Nevertheless, Mr King went on to say that "changes in asset prices can have a major impact on levels of spending and the MPC devotes considerable time to the question of how such changes should affect policy".

A possible sharp slowdown in consumption growth or of record household indebtedness could prompt these imbalances to be unwound.

But there was also the chance that households may adjust more quickly to the implications of a low inflation world for the prices of goods and services than for nominal interest rates or the future growth of nominal incomes.

"A mistaken underestimate of real rates or overestimate of nominal income growth may raise borrowing, spending and asset prices temporarily," Mr King said. "Eventually households learn and consumption adjusts, again possibly sharply."

On the risk of deflation, Mr King said among leading world economies this could only be found in Japan. "Elsewhere, deflation is remote," he said.