LONDON (MNI) – Declining inflation provides scope to keep interest
rates low and to conduct further quantitative easing, if necessary, Bank
of England Governor Mervyn King said in a speech Tuesday.

King highlighted the challenges facing the UK economy, saying the
situation in the Eurozone was “serious” and noting a global level
slowdown. He took encouragement from the decline in UK inflation but his
wide-ranging speech offered no clear guidance on the issue pre-occupying
markets – the likely scale of any further QE.

The BOE Governor saw falling inflation as a bright spot in the UK’s
economic outlook.

“The good news is that the effect on inflation of the rise in VAT,
import costs and energy prices is now waning. Inflation is falling. And,
unless commodity prices rise again – the main risk being tensions over
Iran – it should continue to do so through this year,” King said.

The latest official inflation data showed headline CPI was up 4.2%
on the year, down from 4.8% in November, the largest monthly fall in the
headline rate since April 2009 but still leaving it well above the 2.0%
target set for the MPC.

King believes, however, that inflation is moving back into line
with target.

“After taking into account normal seasonal variation, the rate of
price increases in the past few months has been close to 2% a year,” he
said.

The fall in inflation will ease the prolonged squeeze on real
income growth and it also leaves the door open to further QE.

“With inflation falling back and wage growth subdued, there is
scope for interest rates to remain low, and, if necessary, for further
asset purchases, to prevent inflation falling below the 2% target,” King
said.

Following the November Inflation Report, King had been careful to
say that the MPC needed to be sure that inflation was starting to
fall before taking any further monetary policy action, even though
that report had forecast inflation to fall to 1.3% in 2 years time.

King now seems ready to contemplate further QE should the February
Inflation Report forecasts warrant such a move:

“Our central view is that we’ll see a big improvement (in
inflation) in the first few months of next year. But we haven’t seen
that yet, we’ve got to wait for that to happen; and I don’t want to
count too many chickens.”

While pressure will ease on real income growth “this does not mean
2012 will be an easy year,” King said.

The governor was downbeat about recent developments in the
global economy, describing these as mixed.

While US employment has been increasing, he continued, “in the
major emerging market economies of Brazil, India and China, growth has
eased. In China, export growth continues to fall and there are
indications that domestic demand too is slowing,” he said.

“Closer to home, the depressing effect on growth of the fiscal
contraction in the peripheral European economies is leading to a
downturn in the euro area as a whole. Taken together, we are seeing a
global slowdown,” King said.

“The position of the world economy, especially in the euro area, is
serious,” King said.

“Serious” marks something of an improvement from the kind of grave
language that was being used to describe the situation in December. The
December Financial Stability Report, for instance, called the
outlook ‘exceptionally threatening’.

The BOE governor said three factors, beyond the squeeze on domestic
real take home pay, were shaping the economic environment.

These are “Tight credit conditions, higher household saving and
the dark clouds hanging over the world economy,” King said.

All three are symptoms of the debt hangover post the financial
crisis.

“It became apparent that previous spending patterns and debt levels
were unsustainable. The world economy is moving to a new equilibrium,”
King said.

“After the steepest downturn in output since the 1930s, the UK
economy is in the process of rebalancing. Starting from a position of
excessively leveraged balance sheets, the path of recovery is likely to
be arduous, long and uneven,” he said.

“Helped by the right policy actions, the UK and world economies can
and will recover. And when they do so, they will be on a more
sustainable footing than at any point in the past fifteen years,” King
concluded.

–London newsroom 0044 20 7862 7491; email: drobinson@marketnews.com

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