Bank deputy governor says UK economy may be slow to recover

• Ashley Seager, economics correspondent
• guardian.co.uk, Monday 16 February 2009 15.32 GMT
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The British economy is likely to perform worse than the Bank of England expects and will probably require further action from the monetary policy committee to push inflation back up to its 2% target in the medium term, deputy governor Charles Bean said today.

Bean told a National Farmers Union conference in Birmingham that although the central projection in last week's quarterly inflation report was for a further deterioration in growth before a bounce next year, there was a 75% chance that the picture would turn out worse than this.

"It is possible that efforts to restore the banking system may take longer to bear fruit, and that the adoption of protectionist measures abroad as the downturn deepens may slow the recovery. Consequently the risks are heavily weighted to the downside, with roughly a three in four chance of growth turning out weaker than in the central case," Bean said.

He said the MPC expected inflation to fall back through the 2% target this spring and then stay below target in the medium-term in spite of the MPC's dramatic interest rate cuts of recent months, which has seen Bank Rate slashed from 5% in October to just 1% now.

"So the Monetary Policy Committee will probably need to take further action to return inflation to the target in the medium term," he said, in probable reference to yet another interest rate cut next month and the purchase of government bonds and other financial assets by the central bank with the aim of pushing down longer-term interest rates in the economy and pushing up the money supply.

"This is likely to prove useful now that Bank Rate is nearing its floor," he said, adding that the Bank made its first purchases under its new Asset Purchase Facility ]last Friday.

Under the facility, the Bank can buy corporate bonds and commercial paper directly from companies to boost the flow of money into the corporate sector, which has been particularly hard hit by the credit crunch.

Bean added that a lack of liquidity probably accounted for about half of the 5.5 percentage point spread of investment-grade corporate bonds over government debt. Those purchases, though, will be offset by the issuance of short-term Treasury bills which will take in money from banks, thereby leaving the overall money supply steady.

He said that in future there would have to be more careful regulation of banks requiring them to build up capital reserves or buffers during boom times to protect themselves during a bust such as now.

"In this way, the real economy can be protected from the financial excesses that seem prone to recur. Central banks and banking supervisors are presently working to identify the best way to provide this missing bit of the toolbox."

He concluded, though, that in the end the British economy would recover.

"Right now, we may look to be in for a long and hard economic winter. But, just as the chills of winter each year give way to the promise of spring, you can be equally sure that the current recession will eventually come to an end and economic spring will arrive."