KEY POINTS:
Mervyn King, the Governor of the Bank of England, yesterday issued his starkest warning yet of the dangers facing the British economy, amid fears of a worsening of the global credit crisis and threats to both domestic inflation and growth.
King warned MPs on the House of Commons treasury select committee of "rather uncomfortable" times ahead, with a "big risk" that the credit squeeze could intensify. He said the "sheer uncertainty" and fear of what lies ahead among US banks in particular was driving wholesale interest rates back up to levels seen at the height of the summer credit crises.
King added: "In recent months, the near-term outlook for both inflation and growth has become less benign."
He also had a word of caution for those in the property market.
"For the UK, the consequences of [turmoil in financial markets] are difficult to assess and are likely to be evident first in the housing and commercial property markets."
The immediate challenge facing the bank and its monetary policy committee (MPC) is where to set interest rates. The bank has already indicated that it expects to follow the path indicated by market rates for the next year and a quarter, which would bring interest rates down by more than 1 percentage point, to around 5 per cent in early 2009.
The question is one of timing, with City expectations running at about 60/40 against the chances of a quarter percentage point reduction in the policy rate next week, and the delicacy of the MPC's task was acknowledged by the Governor.
"The challenge for the MPC is that inflation may rise in the near-term, posing a risk to inflation expectations, and could fall below target further ahead in the event of a sharp slowing in output growth," King said. "There is certainly a risk, particularly given the elevated level of inflation expectations, that it [the MPC] will not be able to keep inflation close to the target in the wake of these further increases in commodity and energy prices. There are risks to inflation, there's no doubt about that. We're trying to balance the risks to inflation with the downside risk if activity slows."
David Blanchflower, an external member of the MPC also giving evidence to the MPs, voiced a concern that the bank should "get ahead of the curve". Blanchflower is regarded as a "doveish" figure, and voted for a reduction in interest rates last month, finding himself in a minority of two with the bank's deputy governor for financial stability, Sir John Gieve.
Blanchflower put the probability of an American recession at 50/50. His warning came as the White House lowered its economic growth forecasts for 2008. The White House said the effect of problems in the housing and credit markets, and high oil prices, would be to reduce growth next year to 2.7 per cent from the 3.1 per cent it had previously hoped for.
The Bank of England is also concerned about other international factors, such as the failure of the Chinese Government to revalue the renminbi.
This has meant that the brunt of the adjustment in the American trade deficit has fallen on to other currencies, principally the euro, and made the task of dealing with global economic imbalances more difficult.
Governor insists bank has done its part in easing liquidity pressures
The Bank of England acted again to soften the worst effects of the credit crunch yesterday, announcing that it would be lending £10 billion ($26.6 billion) to the commercial banks at the base rate of 5.75 per cent for a five-week period, rather than for the usual seven days.
Economists said part of that move could be put down to the usual demand for reserves that comes at the year-end as the banks "window dress" their balance sheets, a more acute concern this year than in the past.
However, the injection also reflects the tougher conditions commercial institutions are enduring.
This week, the London interbank offered rate (Libor) - the price at which the banks lend money to one another - rose to six-year peaks for the euro and multi-month highs for sterling and the dollar.
Bank Governor Mervyn King was at pains to tell the financial community that he was on their side following criticism in recent months that he has not done as much as his international counterparts to ease liquidity pressures.
- Independent
