Bank chief backs £20bn gamble

The Governor of the Bank of England today backed the Government's £20bn gamble to drag the UK out of recession.

Mervyn King said the measures outlined in yesterday's Pre-Budget Report seemed "perfectly reasonable" given the "extraordinary circumstances".

But, giving evidence to the Treasury Select Committee, Mr King also warned there was a "long hard road ahead" to restore stability to the economy.

Mr King said Chancellor Alastair Darling's cut in VAT meant it was now "very likely" that the UK would suffer negative inflation next year - but predicted the country would avoid a negative spiral of deflation.

The retail price index (RPI) measure would go below zero, he said, while there was a possibility, although it was not anticipated, that the Government's-preferred consumer price index (CPI) might also do so.

But he went on: "The other definition of deflation - the one economists worry about - is a period of continuing self-reinforcing falls in prices which then make it very difficult for real interest rates to fall to sufficiently low levels to get out of a downturn in spending.

"I do not think we feel that is the position we are in or likely to be in because the likely duration of the period in which the measured inflation rate is negative is likely to be pretty short, indeed the VAT cut itself will be reversed."

The Governor said he had never been put under any pressure by the Chancellor or Prime Minister Gordon Brown over the setting of interest rates.

Mr King told MPs: "As I said in November... I thought in these extraordinary circumstances a modest fiscal stimulus was perfectly reasonable and appropriate, provided it met two conditions.

"The first condition was that it was temporary, and the second condition was that it set out a very clear path back to fiscal sustainability.

"I think the announcements made yesterday met those two conditions, but of course the proof of the pudding, in terms of ensuring that we go back to fiscal sustainability, will be in the eating.

"And there is a long hard path back to fiscal sustainability."

Mr King refused to indicate whether he thought the PBR measures would lead to another interest rate cut next month, saying it would be wrong to speculate.

"That's something all of us on the (Monetary Policy) Committee want to go away and reflect on and discuss. I don't want to give an immediate response.

"We have our meeting coming up in December and you will see the outcome of that. It would be wrong for us to pretend to be able to give a considered reaction to the announcements of yesterday immediately this morning."