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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.
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.
Provided by The Independent—from London, for Independent minds