Don't bank on quick rise

Sep 16 2009 by Iain Laing, The Journal

BANK of England governor Mervyn King has highlighted signs of economic recovery but made it clear that a global recovery is still a long way off.

He told a Treasury Select Committee hearing yesterday that there were indications of a pick-up in activity, both in the UK and overseas, but added that the effects of the financial crisis sparked by the collapse of US investment banking giant Lehman Brothers – a year ago yesterday – will be “pervasive and long-lasting”.

He added that there remained doubts over the sustainability of the global economic recovery.

In response to questioning over recent accusations from former Bank policymaker David Blanchflower that he failed to spot the recession, Mr King said he did not believe the early rate cuts called for by Mr Blanchflower would have made a difference.

His ex-Bank colleague, who quit in May, dubbed Mr King “old iron fist” and hit out at his domination of the nine-strong rate-setting Monetary Policy Committee.

But Mr King argued that his vote had been in the minority on three occasions, which he said contradicted Mr Blanchflower’s criticism.

The central bank boss refused to engage in a war of words with Mr Blanchflower.

He confirmed the Bank of England’s £175bn quantitative easing programme to boost money supply and historically low interest rates of 0.5% were among measures helping support a UK recovery.

“Six months after launching the programme, we are beginning to see its impact on the supply of broad money and nominal spending,” he said.

He warned that the path ahead would be volatile, with inflation set to fall further below the Government’s 2% target before rising above that level.

The risk remains for below-target inflation in the medium term, according to Mr King.

Despite hopes that a recovery is in sight, Mr King cautioned that businesses and households would continue to suffer amid dampened demand and soaring unemployment.

“Growth rates don’t tell the full story, it’s the levels that matter,” he said. “For most businesses and households the recession will continue for some time.”

Banks also face further hefty bad debt losses as the effects of unemployment and recession see individuals and businesses struggle with repayments long after a recovery begins, he said.

This will mean they need to prioritise capital strength to build up a buffer against these future losses, cutting dividends and constraining pay and bonuses, according to Mr King.

Concerns are already growing that the pressure for banks to hold on to cash to bolster their balance sheets is leading them to hoard the extra money being pumped in the market under QE rather than pass it on to borrowers.

Mr King confirmed that the Bank is considering cutting the interest rate for deposits held by banks to dissuade them from storing up cash.

He said a lower deposit rate “could make the banks work a little bit harder” to convert their reserves into other assets.

The committee was told there was some good news on lending trends, with big firms having less difficulty in raising funds, although small businesses continue to struggle.