A nation dazed by several nights of inner-city rioting and arson received no cheer from the Bank of England yesterday. The Governor, Sir Mervyn King, attempted to put a brave face on the latest projections, arguing that he still expects inflation to fall back in 2012 and that the Bank's "central view" is that there will be a gradual recovery over the coming years, rather than a return to recession. Yet this could not disguise the likelihood that the cost of living will continue to rise throughout this year, nor the blow of yet another downgrade in the Bank's growth projections for 2011.
Sir Mervyn argued that the biggest risks facing the UK economy come from the rest of the world in the shape of the eurozone sovereign debt crisis and the prospect of a slowdown in the mighty US economy. The market panic yesterday over the solvency of some large continental banks certainly underlined the Governor's point about the instability of the situation in Europe.
Yet ministers should not take this as licence simply to throw up their hands and say that Britain cannot influence what happens abroad. The Chancellor, George Osborne, must get fully engaged with European finance ministers and policymakers in finding solutions to the eurozone emergency, which despite this week's interventions by the European Central Bank and last month's Brussels deal, is still not even close to resolution. The air of smugness among some Conservative ministers about what is taking place in Europe and the US also needs to be dispelled quickly.
Though it is true to say that the largest risks to the UK economy come from overseas, there are domestic threats too. Sir Mervyn continues to back the Government's deficit reduction timetable, arguing that if growth does evaporate the "automatic stabilisers" of rising welfare payments will help to sustain domestic demand. He was unwilling to be drawn on the subject of quantitative easing, but the Governor has also made it clear in the past that the Bank stands ready to loosen monetary policy if necessary too. Yet the fact is that the bulk of the public spending cuts in the Chancellor's hugely ambitious deficit reduction programme are still to come. Though, as Sir Mervyn pointed out yesterday, the private sector is, at the moment, creating jobs quicker than they are being shed in the public sector, it is far from clear that this will continue when redundancies occur on a much larger scale.
What both Sir Mervyn and Mr Osborne seem unwilling to recognise is that the British economic recovery looks too weak to absorb the fiscal consolidation that is coming down the tracks. Monetary loosening could probably help if the cuts derail growth, but its usefulness is only limited. The Governor argues that the fact that the UK has a clear deficit reduction plan has established us as a safe haven for international investment. There is something in that. But we can stick to the broad deficit reduction framework while shifting the profile of the spending cuts so that their impact is greater in later years, when the recovery has had time to embed itself. The global economic outlook is ominous enough without the Government adding needless domestic risks too.