–Says Liquidity Steps Today Can Only ‘Buy Time’
–Risk Recovery Would Stall, Inflation Below 2% Without Asset Purchases
–Calls For EU Transparency On Bank Losses, Substantial Recapitalisation
–EU Bank Recap. Raises Tough Political Questions For Weak Sovereigns
LONDON (MNI) – There was a risk that UK growth would stall and
inflation would fall below its 2% target without large scale asset
purchases and easy monetary policy, Bank of England Governor Mervyn King
said tonight.
In a speech in Liverpool, King sought to explain why the Monetary
Policy Committee decided at its October meeting to inject a further
stg75 billion through asset purchases into the economy at a time when
inflation remains so far above target.
“Without monetary stimulus – low interest rates and large asset
purchases – there is a risk that growth will stall and inflation fall
below our symmetric 2% target”.
But King warns that easy monetary policy only brings forward
future spending and, without more fundamental rebalancing in the global
economy, economic adjustment will become all the more painful.
“But easy monetary policy, by bringing forward spending from the
future to the present, means that the ultimate adjustment of borrowing
and spending will be even greater. That is our dilemma, and that of
other deficit countries”.
That rebalancing means higher spending in the surplus countries,
such as China and other emerging economies, as well as in Germany and in
Japan. In the deficit countries a greater emphasis on supply side
reforms is needed to boost future income levels.
King noted that the UK had already put itself in a position to
rebalance – but other countries needed to do the same. Without the
latter, the recovery would become “not merely reluctant, but
recalcitrant”.
As far as the UK’s plan for rebalancing and recovery was concerned,
the euro zone crisis represents a setback, King said.
“Our objective must be to steer the UK economy slowly back to a
position of more normal interest rates and lower budget deficits. With a
lower level of sterling and a credible plan to reduce the fiscal deficit
over the medium term, we were on track. But the problems in the euro
area and the marked slowing in the world economy have lengthened the
period over which a return to normality is likely”.
The slowing of the global economy, particularly in the euro area,
was a threat to the UK recovery and economic rebalancing:
“Despite the more competitive level of sterling, the recovery in
our trade position is at risk of stalling”.
The crisis in the wholesale funding markets influenced the QE2
decision, King made clear. Funding for many banks had dried up over the
summer and EU bank share prices are around 35% lower today than at the
start of July, he noted.
“A transparent recognition of losses and a substantial injection of
additional capital are necessary to restore market confidence,” King
said.
But even the latter course is no free lunch, he warned, raising
“difficult political questions about the capacity of the weaker
sovereigns to pay for any recapitalisation of their banks.”
The provision of liquidity measures by central banks and official
lending by governments could only “buy time”, King said, for more
coherent solutions to the underlying problems of solvency of banks and
sovereigns to be put in place.
“Liquidity can never be the answer in itself. And if the time
bought is not used then the size of the debt problem becomes larger and
its cost is gradually transferred from private sector creditors to
taxpayers”.
MPC Right To Look Through High Inflation
King said that the MPC had been right to look through the what he
sees as the present peak in inflation. The 5.2% annual rate in Consumer
Price Inflation seen in September “is likely to be at, or close to, the
peak”.
“…and we expect inflation now to start to fall back, as it did
in the months following the peak in inflation in September 2008.
He continued: “Domestically generated inflation remains subdued –
and on some measures barely above zero”.
“Increases in energy prices, import prices and VAT account for the
current high level of inflation. Once the effect of these temporary
factors begins to dissipate, inflation should fall back sharply early
next year”.
Spare capacity and the crisis in financial markets would pile
downward pressure on inflation in the medium term.
“It is the outlook for inflation, rather than its current rate,
which explains the MPC’s decision to resume asset purchases,” King
said.
King defended the decision to focus QE2 on Gilts, “the only asset
available in sufficient quantity such that the Bank can rapidly inject
large amounts of money into the economy”.
The BOE continued to buy corporate securities but this was aimed
only at making sure that the corporate bond market functions normally.
He said that the role of the Bank here was that of “temporary
market-maker in a dysfunctional but previously liquid market” and he
noted the BOE had previously achieved its objectives in the corporate
bond market without spending large sums of money.
The need to help small to medium sized enterprises access credit is
a more pressing and urgent issue, King said, with the best solution to
provide the credit through banks.
BOE and Treasury officials, he said, are working on approaches
which would incentivise banks to increase lending to SMEs as banks could
“assess credit risk in a way that no other institution could do in the
immediate future”.
–London bureau: +4420 862 7492; email: dthomas@marketnews.com
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