King Backs Cameron Budget Plan as BOE Lowers Outlook: Economy

Bank of England Governor Mervyn King signaled continued support for Prime Minister David Cameron’s budget squeeze as he cut forecasts for economic growth and said Britain’s recovery will be a “slow process.”

“If you go back to 2010 when the rebalancing program was put in place, that looked pretty sensible,” King told reporters in London today. The plan’s three main elements “still seem to me exactly the right three things,” he said.

The government’s spending cuts, along with the euro-area debt crisis, have curbed demand in the U.K. While the economy shrank the most in more than three years in the second quarter, Cameron and Chancellor of the Exchequer George Osborne have pushed back against calls from the opposition Labour Party to scale back the fiscal program, saying it is needed to insulate the country from the euro-area debt turmoil.

King was speaking after publishing the central bank’s quarterly Inflation Report, which included forecasts showing annual gross-domestic-product growth of about 2 percent in two years. That compares with a projection in May of 2.5 percent.

Asked whether the government should have a “plan B,” King said “no,” and then detailed his backing for the main elements of the deficit-reduction program; cutting public spending, focusing on tax rates and allowing automatic stabilizers to take effect. Automatic stabilizers refers to countercyclical fiscal policy that limits economic fluctuations, such as increased government spending on welfare benefits during a recession.

He said while the government has cut spending faster than planned, contributing to a weaker-than-expected economic performance, “that means there’s less consolidation to do in the future.”

Exaggerated Weakness

The Bank of England also said in the report that while one- time factors exaggerated the second-quarter contraction, the economy is likely to remain subdued in the near term. Britain faces a struggle to recover from a double-dip recession amid the efforts to cut the budget deficit and the euro-area debt crisis.

It said the outlook for the U.K. growth is “unusually uncertain” and the greatest threat “stems from the risk that an effective policy response is not implemented sufficiently promptly in the euro area.”

“Many of the conditions necessary for a recovery are in place, and the Monetary Policy Committee will continue to do all it can to bring about that recovery,” King said. “As I have said many times, the recovery and rebalancing of our economy will be a long, slow process.”

‘Change of Course’

Rachel Reeves, a Labour Treasury spokeswoman, said the lower Bank of England forecasts reinforced the need for a change to the budget program.

“The chancellor’s policies aren’t only causing short term pain, but long-term damage to our economy too,” she said in an e-mailed statement. “We urgently need a change of course.”

The central bank also published inflation forecasts today that signal more stimulus may be needed to meet its 2 percent consumer-price goal. It kept its bond-purchase target at 375 billion pounds ($587 billion) and its benchmark interest rate at 0.5 percent on Aug. 2. It increased the quantitative-easing target by 50 billion pounds last month in a program due to end in November.

According to the report, inflation is a “little more likely to be below” the goal for “much of the second half of the forecast period.” U.K. inflation slowed to 2.4 percent in June and the central bank said the risks are “broadly balanced by the end of the forecast period.”

The projections are based on QE staying at its current level and an interest-rate reduction by the second quarter of 2013, according to market forecasts published in the report.

Rate Cut

King said today that the Bank of England’s view for now is that a reduction in the interest rate would be more damaging than beneficial. He said that policy makers can take other measures if needed to meet the inflation goal, including an expansion of bond purchases.

King’s tone was “not quite as dovish as some may have been expecting,” said David Tinsley, and economist BNP Paribas SA in London. “But as far as policy is concerned it is clear the current projection falls well short of the 2 percent target and on this basis more QE in November appears likely.”

Investors have scaled back bets on a rate reduction, according to Sonia forward contracts. A cut isn’t priced in through July next year, data from Tullett Prebon Plc shows. Earlier this month, traders were betting on a reduction as soon as this October.

Export Pressure

The central bank said a “gentle pickup in the growth of households’ real incomes, combined with QE and the Funding for Lending Scheme, should spur a modest recovery.”

Still, it added that exports have fallen due to slowing global demand and that the pound’s appreciation over the past year, particularly against the euro, may hamper exports.

If the gains were to continue, “it could make it harder for British producers to compete in world markets,” the central bank said.

Elsewhere, data showed German exports dropped more than economists forecast in June and industrial production declined. Exports, adjusted for work days and seasonal changes, fell 1.5 percent from May, when they jumped 4.2 percent, the Federal Statistics Office said. Industrial output slipped 0.9 percent.

Also today, Spanish industrial production fell 6.3 percent in June from a year earlier, a 10th consecutive decline, a separate report showed.

In Asia, Japan posted a bigger-than-estimated current- account surplus in June as oil prices fell to a low for the year, easing concern that the nation is at immediate risk of needing overseas funding to service its debt burden.

The excess in the widest measure of the nation’s trade was 433.3 billion yen ($5.5 billion), compared with 215.1 billion yen in May. The median estimate of 21 economists surveyed by Bloomberg News was for a surplus of 415.4 billion yen.

The decline in crude prices limited Japan’s fuel bills, as trade figures showed the first drop in imports since 2009, after last year’s earthquake and nuclear meltdown bolstered demand for imported oil.

To contact the reporters on this story: Jennifer Ryan in London at jryan13@bloomberg.net; Scott Hamilton in London at shamilton8@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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