(Updates with comments from King in sixth paragraph, Tucker in 11th.)
June 28 (Bloomberg) -- Bank of England Governor Mervyn King defended policy makers’ decision to hold interest rates at a record low as he noted risks to the U.K. economic recovery from the sovereign-debt crisis in the euro area.
The bank’s “remit does allow for us to not to try to bring inflation back to the target immediately if that were to lead to undesirable volatility in output,” King said at the U.K. Parliament’s Treasury Committee in London today. “Most of us on the Monetary Policy Committee have taken the view that to tighten policy now would be to risk that.”
King highlighted the threats from the debt crisis and said the view among investors on the chance of a default in Greece is high enough for the central bank to consider “contingency plans.” The bank held its key rate at a record low of 0.5 percent this month to aid the recovery even after inflation stayed at 4.5 percent in May, more than twice its goal.
“There is sufficient concern in the market about the possibility of default for us to think carefully about contingency plans and the consequences of this event,” King said, referring to Greece.
Greek unions today shut down government services, halted public transport and disrupted flights as Prime Minister George Papandreou urged lawmakers to back tougher budget cuts to secure a new aid package that will help avoid a default.
“There are dangers with just buying time because if you forget the problem and say ‘Well, thank goodness that’s gone away for a few weeks,’ that can be a very dangerous attitude,” King said. “If the underlying problems have not changed, the crisis comes back in an even more severe form and that has been the case right through the past 18 months in trying to deal with Greece, Portugal and Ireland.”
Fellow Bank of England policy makers Adam Posen, who has called for the bank to expand its bond-purchase program, and David Miles, backed the position on interest rates at the Treasury Committee today, saying consumer spending is weak, wage growth is low and longer-term inflation expectations have not risen markedly. Miles said he would more likely vote for further bond purchases if “downside risks,” such as those from an escalation of the euro-area debt crisis, materialized.
King said that while the current level of inflation is “clearly uncomfortably high,” the majority of the MPC hasn’t seen signs that it is feeding through to second-round effects.
“If we were to see that, then I think we would be concerned that our ability to meet the inflation target in the medium term might require a much more severe policy further down the road,” he said.
Investors have pushed back bets on the first increase to beyond May 2012, according to forward contracts on the sterling overnight interbank average. On June 1, traders were betting on an increase in February, data from Tullett Prebon Plc showed.
Asked about the impact of a rate increase on the consumer, King said moves in the benchmark may not be fully passed on to retail rates. As the key rate rises, “you would expect it to be accompanied by a process in which the spread between the rates at which banks charge their borrowers and” the Bank of England rate “would not go back to the very low levels that they were, but would undoubtedly narrow.”
Bank of England Chief Economist Spencer Dale, who favors a quarter-point interest-rate increase, also noted the “fragility” of the recovery. He said in a report to the committee today there are “merits to keeping bank rate on hold or even increasing the scale of asset purchases further.”
Minutes of the MPC’s June 8-9 meeting showed that for some members, “it was possible that further asset purchases might become warranted if the downside risks to medium-term inflation materialized.”
Deputy Governor Paul Tucker said that he has a “high threshold” when considering the need for injecting more stimulus into the economy. “I am one of those who from the back end of last year has worried about the possibility of an upward drift in inflation expectations,” he said.
The pound fell against the dollar today and was at $1.5969 as of 12:50 p.m. in London, down 0.1 percent from yesterday. Government bonds fell, pushing the yield on the 10-year gilt 5 basis points higher to 3.21 percent.
--With assistance from Svenja O’Donnell in London. Editors: Fergal O’Brien, Simone Meier
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