Bank will print money as UK sees 'deep recession'
By Sean O'Grady, Economics Editor
Thursday, 12 February 2009
The Bank of England is ready to launch a policy of "quantitative easing"
– printing money – in an effort to lift the economy out of what the Bank
calls "a deep recession". The Bank's central forecast, in its latest
Inflation Report, suggests that annual growth in the UK economy will hit
a nadir of -4 per cent in the summer of this year.
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The Bank warns that "the risks surrounding the central projection for
growth are judged to be weighted heavily to the downside", with an
outside chance that the economy could, at its worst, contract by an
annual rate of 6 per cent in the summer, a slump of historic
proportions.
This represents a savage downgrade from the predictions the Bank was
making only last November. The report now suggests an overall
contraction in 2009 of about 2.5 per cent, in line with recent forecasts
from the IMF and others, leaving Britain at the bottom of the
international growth "league table". If the growth forecast proves
accurate, it will be the UK economy's worst year since the Second World
War.
In the Budget next month or in early April, the Chancellor, Alistair
Darling, is almost certain to follow the Bank and radically revise the
Government's growth forecast for this year down from the current -1 per
cent, with chilling implications for the scale of public borrowing,
already heading to record levels. Sterling tumbled as the Bank published
its views, falling as much as 1.5 per cent against the dollar.
As the scope for further cuts in interest rates diminishes – the
Monetary Policy Committee has cut rates by 3.5 percentage points since
the start of November, to 1 per cent – the Bank seems ready to go
further, and as soon as the next MPC meeting on 4 and 5 March. The
Governor of the Bank, Mervyn King, declared: "Bank rate doesn't have to
go to zero. ... We are now at the range where it doesn't make a great
deal of difference where the Bank rate is – we are at the point where we
need to think about taking other sorts of action."
At the end of this week, the Bank will launch its Asset Purchase Scheme,
aimed initially at the narrower target of repairing the malfunctioning
market for corporate debt. A wider programme of "unfunded" asset
purchases of gilts and other securities seems likely to be agreed by the
MPC in March. This will raise the commercial banks' reserves and
increase the money supply, inducing a modest burst of inflation to
combat falling prices. How far and how fast this will proceed has yet to
be decided by the MPC, and must be formally approved by the Government.
However, the inflation forecast published by the Bank yesterday, showing
the consumer price index as low as 0.5 per cent by 2010 and still well
below the 2 per cent target by 2012, suggests this quantitative easing
may have to be very substantial.
Mr King commented: "The projections ... imply that further easing in
monetary policy may well be required. That is likely to include actions
aimed at increasing the supply of money to stimulate nominal spending."
Even so, there was doubt in the City as to whether even this approach
will work. Philip Shaw, at Investec Securities, said: "There are no
indications over how successful quantitative easing would be in
stimulating lending and activity. The Japanese experiment earlier this
decade is largely thought to have been ineffective. There is no
guarantee that banks' excess liquidity would find its way to households
or businesses, as banks could hoard the cash at the Bank of England or
lend to non-bank financial corporations.
Malcolm Barr, of JP Morgan, added: "Given that the relationship between
broad money and central bank reserves is not very stable, we wonder
whether calibrating how much to supply versus what money growth is doing
will be workable in practice."
Whatever the prospects for policy, the Bank was clear about the short-
term pain from a combination of depressed global demand and trade, the
continuing shortage of credit and de-stocking. The most visible effect
of the recession, or depression as it is being called in some quarters,
is the steep rise in the dole queues. Yesterday the Office for National
Statistics reported unemployment had reached 1.97 million between
October and December, a 12-year high.
Mr King specifically mentioned the growing threat of protectionism, and
the uncertainties about how quickly the various measures taken by the
authorities around the world – banking rescues, fiscal stimulus
packages, interest rate cuts and printing money – would work. In an
occasionally irascible performance, Mr King tried to assure reporters
that "we have a policy framework which is capable of getting us out of
this and these measures will work". The Bank forecasts a very strong
recovery in the latter half of this year and in 2010. The 25 per cent
decline in sterling since the summer of 2007 will, the Bank believes,
foster a "re-balancing" of the British economy, towards investment and
exports, and boost the economic recovery.
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