Bank of England policy maker Ben Broadbent said the U.K. central bank will respond if the worst euro-area risks are realized, while acknowledging there is a limit to what it can do.
“Were the still unlikely worst-case risks in the euro area actually to be realized, then our own monetary policy would again play its part in mitigating the impact,” Broadbent said in a speech in London today. “While they are both necessary and effective, these domestic interventions have their limits. It remains the case that, for the time being at least, the most important policy decisions affecting the U.K. are being taken in other parts of the continent.”
Prime Minister David Cameron is meeting with Bank of England Governor Mervyn King today to discuss the crisis in the euro area amid mounting speculation of a breakup of the 17- nation currency bloc. The Bank of England has kept open the possibility of doing more so-called quantitative easing after it stopped stimulus this month.
“Fears have increased of a rare but bad economic outcome,” Broadbent said. “These heightened fears may already have been affecting the growth of U.K. activity, investment and productivity for some time.”
The policy maker said that there is now a “higher hurdle for risky investment,” reflecting “a rise in the perceived probability of an extremely bad economic outcome.”
“Markets and businesses possess ‘animal spirits’ and can overreact to events,” he said. “They may have done so again. But there’s probably a premium on risky investments because there is genuine economic risk.”
Broadbent also said that any response by the Bank of England to a deterioration in the U.K. economy may already be priced in by investors.
“Markets should, and presumably do, know that, because such a downturn would threaten to push inflation to dangerously low levels, it would also be met with further monetary easing,” Broadbent said. “To a degree, therefore, that response is already factored into market yields and the prevailing cost of capital.”