Bank of England Governor Mervyn King said slower inflation gives policy makers room to increase bond purchases to aid the U.K. economy and guard against a “renewed severe downturn.”
“With inflation falling back and wage growth subdued, there is scope for interest rates to remain low, and, if necessary, for further asset purchases, to prevent inflation falling below the 2 percent target,” King said late yesterday in Brighton, England. He also said tight credit conditions “will continue to act as a headwind to the economic recovery.”
Data today may show the economy shrank in the fourth quarter, pushing Britain to the edge of a second recession in 2 1/2 years. The central bank will also publish minutes of its Jan. 12 decision to leave the target for bond purchases at 275 billion pounds ($429 billion) and the key interest rate at a record low of 0.5 percent.
The International Monetary Fund cut its 2012 U.K. growth forecast yesterday to 0.6 percent from 1.6 percent. It lowered its global projection to 3.3 percent from 4 percent and said the euro area may enter a “mild recession.” European finance ministers ended two days of talks in Brussels with a push on bondholders to provide greater debt relief for Greece.
“The depressing effect on growth of the fiscal contraction in the peripheral European economies is leading to a downturn in the euro area as a whole,” King said, adding that there are signs major emerging economies are cooling. “Taken together, we are seeing a global slowdown.”
Nevertheless, he added that while the position of the global economy is “serious,” there is “no reason to despair” as “all crises come to an end.”
The bank’s bond purchases have helped to keep gilt yields close to record lows. The 10-year yield was at 2.21 percent as of 7:58 a.m. London, compared with 1.917 percent on Jan. 18, the lowest since Bloomberg began compiling the data in 1989.
King said the links between British banks and Europe mean the debt crisis will create a drag on U.K. bank lending.
“Until the problems in the euro area are resolved, concerns about the scale of such exposures will mean that U.K. banks will continue to experience elevated funding costs,” he said. “As a result, their ability to provide credit on reasonable terms to businesses and households will remain impaired.”
A bright spot for consumers has been cooling inflation after what King said was a “ferocious squeeze” in 2011. Consumer-price growth slowed to 4.2 percent last month and may continue to ease as last year’s sales-tax increase and a commodity-price spike drop out of calculations.
“As we head into a challenging year for the world economy, we have seen more positive sentiment in financial markets, and, at home, a fall in inflation,” he said. “But none of this implies that 2012 will be an easy year.”
To support lending, King said the central bank “stands ready to provide liquidity to healthy banks against good collateral should market conditions deteriorate.” He also said as lenders repair balance sheets, they should limit payouts to employees and shareholders in favor of building capital.
King also warned on the possible consequences of excessive pay at banks for the second time in a week. He urged executives who set pay to ensure that compensation is fair at a time when those who didn’t cause the financial crisis are being forced to suffer its consequences. On Jan. 17, he said banks may damage their reputations with excessive compensation at a time when their share-price performance has “hardly been stellar.”
“The legitimacy of a market economy will inevitably be challenged if rewards go disproportionately to a small elite, especially one which benefited from the support of taxpayers,” King said yesterday. “Those taking decisions on remuneration, in the financial sector and elsewhere, need to understand that a market economy rests not just on incentives, but on the acceptance that the distribution of rewards is fair.”