Bank of England Governor Mervyn King said it may be appropriate to review the U.K.’s inflation- targeting regime, and that government measures to strengthen the economy are needed to underpin a “gentle recovery.”
“It would be sensible to review the arrangements for setting monetary policy,” King said in Belfast yesterday in his final speech outside London before he retires in June. “There are certainly aspects of the inflation-targeting regime to consider.”
In a wide-ranging address, King said the BOE is ready to add more stimulus if needed, though monetary policy is not a “panacea” and more must be done to strengthen banks and implement structural reforms. With his successor, Bank of Canada Governor Mark Carney, having raised the topic of the potential limits of inflation targeting, King welcomed that public debate.
King said his view remains that a long-run 2 percent inflation target “should be an essential part of our macroeconomic framework,” and it would be “irresponsible to lose that.” He added that the BOE has the flexibility to allow above-target inflation during slumps.
No Easy Recovery
Carney, who is scheduled to take over from King on July 1, has discussed the virtues of a nominal gross domestic product target as a policy tool.
“The challenge we face is not the inadequacy of the framework, but the fact that there is no easy route to recovery after a major banking crisis,” King said in the speech, delivered to the Confederation of British Industry. “Recovery is inevitably slow and protracted.”
“Although the arrival of the new governor might stimulate a debate about the monetary policy framework, the arguments for retaining the 2 percent inflation target along with some degree of flexibility remain strong,” said Simon Hayes, an economist at Barclays Plc in London. “We think it would be unwise to jettison flexible inflation targeting, and we do not expect the government to do so.”
The pound slipped 0.1 percent to $1.5818 against the dollar as of 7:47 a.m. in London, close to the lowest in almost five months.
King spoke on the eve of the release of the Bank of England’s minutes at 9:30 a.m. in London, which will show if David Miles kept up his call for more stimulus against the majority of policy makers who voted for no change. In unemployment data at the same time, the number of jobless- benefit claimants probably rose by 500 in December, according to the median forecast of 28 economists in a Bloomberg News survey.
Prime Minister David Cameron will also deliver a speech today, in which he will promise a referendum on whether Britain should leave the European Union, allowing U.K. voters to decide on breaking up the 27-nation bloc.
King said policy makers will continue to assess the merits of an interest-rate reduction, already at a record-low 0.5 percent, and the need for further bond purchases. “Be in no doubt that we are ready to provide more stimulus if it is needed,” he said.
King added that prolonged use of monetary stimulus may have side effects, including pushing down long-term bond yields to “unsustainably low levels” that pose a risk to financial stability. He said authorities must press on with measures to improve confidence in banks, boost the supply potential of the economy and rebalance domestic demand away from countries with trade deficits to those with surpluses.
“Since the crisis began, real wages have fallen by almost 10 percent -- a large but necessary adjustment,” King said. “Supply reforms can make that adjustment more palatable, and, by raising expected future incomes, they increase the rate of return on new investment and encourage spending.”
While it’s not for the central bank to design that adjustment, “in economic terms there has never been a better time for supply-side reform,” he said.
On banks, King said that while they are now “overflowing with liquidity,” there is still concern about their resilience, which is impacting financing costs and their ability to lend. He also said there is “no reason” why the government’s stakes in Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc (LLOY) could not be sold “within a relatively short period.”
King also said that a resolution of the euro-area debt crisis would help Britain’s recovery. The near-term outlook in the currency region is “weak” and the prospect of longer-term tension is undermining company investment, he said. Still, he offered some optimism.
“If we embark on the type of program I have outlined tonight, I believe we can roll back the black cloud of uncertainty darkening the outlook for demand, allow the rays of supply optimism to peer through, and sustain a recovery based on a successful rebalancing of the U.K. economy,” he said.
Though King didn’t comment on the pound’s current value, he said its 25 percent decline between late 2007 and the beginning of 2009 was “certainly necessary for a full rebalancing of our economy.”
He also warned the global economy faces potential “currency wars” unless countries set aside the view that lower exchange rates are needed to stimulate their economies and accept the need to rebalance domestic demand toward trade surplus countries.
“The existing configuration of exchange rates is unlikely to deliver stability,” he said. “For almost two decades the world has struggled with, but failed to resolve, this problem. So it is hard to be optimistic about how easy it will be to manage the resulting tensions.”
GDP data on Jan. 25 will probably show the economy was “considerably weaker” in the fourth quarter than the previous three months, King said. He also said inflation “is set to remain above target for much of this year” because of higher energy costs and university fees.
Still, “there are good reasons to suppose that a gentle recovery is under way’,” King said. “Our economy is recovering, more slowly than we might wish, but we are moving in the right direction.”
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