Recovery will be long and slow, warns Bank

King expects quantitative easing policy to keep inflation below 2% target / Recession is deeper than Monetary Policy Committee predicted three months ago
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The Independent Online

Britain's economy faces a slow and protracted recovery and "we will still find ourselves in a difficult position for a long time to come", the Bank of England's Governor warned yesterday.

Mervyn King said the world economy "remains in a deep recession and its financial system in a fragile condition". The UK economy showed signs of stabilising now, he added, but the upturn could be so muted that many people will not notice the difference.

Mr King said: "I don't think it's unrealistic to suppose that growth rates come back but that doesn't mean that, as far as most people and most companies are concerned, the recession will feel as if it is over."

According to the Bank's quarterly Inflation Report, the recovery will be constrained as banks rebuild their strength and remain reluctant to lend, and as households and the Government set about paying off their debts. As in his many previous recent statements, the Governor emphasised that the banking system had to be fixed. He said: "We have to recognise that the banking sector is still in a bad way and it will take several years for it to repair balance sheets and be weaned off public support and in a position to lend again normally."

The Bank's central projections for growth were "somewhat stronger than in the May report", with the recession reaching its nadir during the summer and growth returning by about January, which was also in line with forecasts made by the Chancellor, Alistair Darling, in his last Budget.

Mr King said that since its last Inflation Report, the Monetary Policy Committee had seen both more encouraging short-term signals about the economy, but also some deterioration in the historical data. "The recession appears deeper than the MPC thought likely at the time of the May report," he said. "But as the impact of de-stocking has turned round and the effects of a lower exchange rate and the policy stimulus have begun to come through, the pace of contraction has moderated."

The Bank maintained its dovish stance on inflation, predicting that the rate would still be below its target of 2 per cent even in 2012, despite its £175bn programme of quantitative easing to increase the money supply. But that is assuming that interest rates rise between now and then, as the markets believe they will. The rate of inflation would, says the Bank, return to 2 per cent if the current 0.5 per cent Bank rate is held until then. City economists took this to mean that the Bank intends to keep rates very low for at least another year. Sterling fell on the growing realisation among traders that rates seem destined to be lower than previous market expectations for a prolonged period.

Mr King said quantitative easing had helped to ease the supply and cost of credit, compared to what it might have been had the policy not been launched in March and extended by £50bn last week.

The Governor said the MPC would continue to review its QE policy on a month by month basis. The asset purchase scheme for quantitative easing involves buying gilts and smaller quantities of private-sector securities to drive down yields. This, it is believed, has helped to stimulate equity and other capital markets and will in due course push spending and inflation back to the Bank's 2 per cent target.

"The asset purchases have had some effect. It may not have got money growth back to where we would like it to be in the medium term, but it may have prevented a more serious fall. We had hope that over the next six to nine months we would see more signs of a pick-up in money growth.

"We will keep that stock of asset purchases there until we see some signs of growth in nominal spending in the economy returning."

The Bank also seemed more relaxed than some media commentators about the increase in the cost of credit as the banks attempt to rebuild their margins, profits and capital.

"Real interest rates, at least to mortgage borrowers, have fallen," Mr King went on. "I accept that they have not fallen much to corporate borrowers, that's because banks have been widening the spreads in order to try to rebuild their balance sheets and this is part of the process of the healing of the banking sector. I see no easy way around that in the short-run. We need to create in the longer run a healthier banking sector, one with a different structure of banking and a more competitive banking sector. Those are important long-run objectives."

In a rebuke to the apparent belief in some banking circles that things can go back to "business as usual", Mr King pointed out that it was not the banks but "ordinary companies" that had been worst hit by the "mayhem" unleashed by the financial crisis.

He rejected the view of a former colleague, Charles Goodhart, that monies held by the commercial banks with the Bank of England were "socially useless". Critics say the flow of money from quantitative easing is not coming through quickly enough to consumers and small businesses.

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