UK economy is returning to growth, says Governor

Bernanke also says recession is over in the US

The Governor of the Bank of England told MPs yesterday that he believes the recession may soon be over, at least in the technical sense of the term. "Falls in output have broadly come to an end and we are beginning to see some very small signs of positive growth," Mervyn King said.

His comments were echoed on the other side of the Atlantic by Ben Bernanke, the chairman of the US Federal Reserve, who told an audience at the Brookings Institute that America's recession was "likely over". Both central bankers, however, were keen to stress that any recovery would be slow. "Even though from a technical perspective the recession is very likely over at this point, it's still going to feel like a very weak economy for some time," Mr Bernanke addedd.

Despite reporting signs that growth had resumed in the third quarter, Mr King stressed how protracted the recovery may be, saying: "There is a long way to go before the level of output gets back to where it was." The "strength and sustainability" of the recovery were still highly uncertain, he added. Giving evidence to the Commons Treasury select committee, Mr King said: "The balance of risks to inflation around the 2 per cent target remains on the downside."

Inflation fell again last month, to 1.6 per cent, according to figures released yesterday. Speaking a year after the catastrophic collapse of Lehman Brothers, Mr King also warned that Britain's banks would be required over the next five years to build up "substantial amounts of capital" to provide a buffer against future financial crises.

Recognising the difficulty of doing that, and the continuing fragility of the financial system, he also forecast further losses on the Bank's normal lending activities, beyond the huge write-offs on sub-prime and other derivatives during the credit crisis. He criticised the widespread idea that in the wake of Lehman's no systemic institution would be allowed to default again. "We cannot have institutions in the private sector that cannot fail ... that is asking for trouble," Mr King said.

The Governor also made clear he was not prepared to continue to see taxpayers subsidising the trading activities of commercial banks that enjoyed an effective state guarantee and access to cheap capital. He called again for a "credible" plan to return public finances to order, but resisted efforts by some MPs to drag him into the debate on public spending cuts, merely adding that monetary policy would "take account of" fiscal policy.

To make the policy of quantitative easing more effective, Mr King repeated that he was prepared to consider charging banks a fee on the "excess" reserves they hold with the Bank, though only as a "useful supplement".

"There is a long, hard road ahead to restructure our financial sector. Over a number of years, banks will be required to hold much larger and more effective buffers of capital and liquid assets to make the financial system less susceptible to the sort of panic that occurred last year," said Mr King.

Of more concern to bank executives is the Governor's implicit suggestion that retail or utility banking ought to be separated from investment banking, and that the large international banking groups should be broken up to address what he called the "too important to fail issue".

"The real question about the financial sector is should we subsidise it?" he asked. "Giving deposit insurance, guaranteeing the payment system, makes a lot of sense, but nobody in their right minds... would suggest the guarantee we give the utility aspect of banking to fund risky proprietary trading. It is something we need to deal with. It is very important."

Mr King's sentiments were echoed by the Chancellor, Alistair Darling, who said: "It is absolutely essential that banks need to be adequately capitalised and the more risky their activities, the greater capital buffer they need."

The Bank's ability to maintain its monetary policy, with bank rate at 0.5 per cent and a £175bn programme of quantitative easing, may be stymied by the "stickiness" of underlying inflation. On the Consumer Prices Index measure, annual price rises are down to 1.6 per cent from 1.8 per cent in July. Food inflation slowed from 4.1 per cent to 1.9 per cent and utility price inflation fell from 9.8 per cent to 4.2 per cent. But stripping out volatile items such as food leaves the underlying rate of 1.8 per cent unaltered.

The Retail Prices Index, which includes mortgage bills, has been below zero for some months, but rose from minus 1.4 per cent to minus 1.3 per cent.

Trading insults: King bites back at Blanchflower

Hell hath no fury like a central banker scorned. A week after former Monetary Policy Committee member David Blanchflower launched a scathing attack on Mervyn King, "the old iron fist", the Governor fought back yesterday, albeit in terms befitting his status.

"[David's] recollection of events do not coincide with mine," Mr King told the Treasury Select Committee. "I'm sorry he has chosen to comment in this way."

Mr King said that his rival's long campaign for lower interest rates would not "have made an awful lot of difference" had it been successful and said he had been right to tackle Mr Blanchflower after he publicly attacked the Bank's Inflation Report last year. "It didn't seem very sensible, having agreed privately and signed up to the view in the report, then publicly to dissent from it."