Debt could trigger stagnation, says BoE

The UK could suffer a Japanese-style stagnation if its mountain of household debt triggers a consumer slump, the chief adviser to the Governor of the Bank of England warned yesterday. Alastair Clark said households could not continue to build up record amounts of debt without an adjustment at some point. "In the household sector debt levels have continued to rise," he told the International Arab Banking Summit in London.

"In general we do not see an imminent danger of a disorderly adjustment in these imbalances but there will need to be some adjustment over time. Japan's experience since the early 1990s provides a salutary indication of some of the problems that can arise from excessive accumulation of debt supporting an exaggerated rise in asset prices."

Lax monetary policy in Japan in the late 1980s helped create a speculative asset price bubble - in property and shares - that burst, leaving the economy flat on its back for a decade.

Recent figures from the Bank showed that household debt totalled a record £985bn in April, almost the size of Britain's entire annual economic output. New borrowing is growing by more than 15 per cent a year.

His comments came a week after Mervyn King, the Governor, warned the risk of a house price crash had risen in recent weeks. Mr King expects to face tough questions over his comments, which are reported to have angered Gordon Brown, from MPs on the Commons Treasury Select Committee today.

The International Monetary Fund recently said the main risk to Britain's economy was the possibility of an abrupt housing market correction. A sudden slump in prices would eliminate the boost to spending that has come from households borrowing against the rising value of their homes and would probably prompt consumers to start saving. This in turn could cause problems for the banking sector if falling prices and rising interest payments pushed households into default on their mortgages.

The Bank will give more details of its views about the strength of the banking sector next week when it publishes its bi-annual financial stability review. Mr Clark, who was the bank's executive director for financial stability for almost seven years, said all major economies were carrying high levels of consumer, corporate or government debt.

He highlighted Japan's fiscal deficit of 8 per cent of GDP, the 5 per cent shortfall in the US and the fact that several members of the euro were breaking the Maastricht treaty limits.