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A difficult position for a long time to come

“We will still find ourselves in a difficult position for a long time to come”, said Mervyn King, governor of the Bank of England, in the Bank’s latest quarterly inflation report. He noted that the economy is still in a deep recession and our financial system remains “fragile”.

 

In fact the governor reported bad news and good news as well as putting out a warning about the future. The bad news was that the recession had been more severe than the Bank had anticipated, even as recently as its last report in May. The good news is that: “….as the impact of de-stocking has turned round and the effects of a lower exchange rate and the policy stimulus have begun to come through, the pace of contraction has moderated.

 

In fact, the Bank is now making a central forecast of UK growth at about 1.8% next year, which is up from the previous 1.1% forecast in May. This is in spite of the fact that the forecast for growth this year has worsened from minus 3.9% predicted in May to a revised 4.4% forecast now. So although the recession was deeper than originally thought, it will bounce back more quickly than most commentators have been predicting.

 

The Bank is predicting jam tomorrow, or at least next year - if we are lucky.

The Bank is predicting jam tomorrow, or at least next year - if we are lucky.

As far as inflation is concerned the Bank expects that the rate will be below its 2% target up until 2012, even given the £175bn programme of quantitative easing which has been injecting increasing liquidity into the economy. The UK has in fact increased liquidity by a higher proportion of GDP than any other country in the current crisis, as confirmed this week by research published by the International Monetary Fund.

 

It is now expected that interest rates are likely to remain at 0.5% until well into 2011. This caused an immediate fall in the price of sterling as traders were forced to revise their forecasts.

 

What are the warnings for the future? There are still concerns about the level of unemployment. If this continues to grow, as a lagging indicator of the recession, then we can expect a cutback in consumer spending and a growth in savings, which will help to put a brake on the extent of any recovery.

 

There are also concerns about the impact of quantitative easing so far. The governor said that: “The asset purchases have had some effect. It may not have got money growth back to where we would like it to be in the medium term, but it may have prevented a more serious fall.” He went on to say that he hoped money supply growth would pick up over the next two to three quarters.

 

He also noted that firms were currently constricted from raising prices, but that a further fall in the value of sterling will put upward pressure on import prices and if this becomes too great, may cause the Bank to raise interest rates to prevent inflation.

 

Finally, the Bank is concerned with the degree to which the banking system continues to be undercapitalised. The governor said that: “The amount of capital raised so far has been small relative to the size of banks’ balance sheets” and pointed out that if this continues it may put a cap on bank lending growth and hinder the recovery.

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Posted in Bank of England, Consumer Expenditure, economic growth, Exchange Rates, Inflation, Lending, Money Supply, recession, sterling, unemployment

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