Former Bank insider warns on UK future

Aug 11 2009 by Peter McCusker, The Journal

THE struggling UK economy is still in danger of slipping into a Japan-style “lost decade”, says a former Bank of England rate-setter.

The warning from Sushil Wadhwani, a former member of the monetary policy committee, comes ahead of the Bank’s latest economic forecasts tomorrow.

These are expected to show worsening UK growth prospects and a lingering threat of long-term deflation – falling prices – after the Bank elected to pump an extra £50bn into the economy in a surprise move.

Despite tentative signs of recovery, Mr Wadhwani says the economy could dip down again next year after a brief bounce – following a similar pattern to Japan in the early 1990s.

“People think things will then return to normal – but these bounces are driven by temporary factors – for instance, destocking turning to restocking, or factors like that you go only so long without replacing your car, or by the VAT stimulus.”

He added: “The second half of 2010 could be more difficult for the UK than 2009. There will be a big fiscal tightening, the VAT tax cut will have gone, and the world as a whole will be slowing at that point. You will have several things coming together which will dampen the economy.”

Rate-setters are desperate to avoid the UK sliding into the kind of deflationary spiral which left Japan’s economy in the doldrums for a decade.

In the UK, Retail Prices Index inflation is currently negative, although this should be temporary due to falling house prices and mortgage interest payments.

But if the Bank’s Consumer Prices Index (CPI) benchmark – which discounts these factors – turns negative, it could signal a long-term battle with deflation.