King Says BOE Faces Hard Choice as Euro Area Storm Rages
Thursday, 17 May 2012 | 11:00
Bank of England Governor Mervyn King said officials have prepared for dangers posed by Europe’s debt crisis, after the bank lowered growth forecasts and raised predictions for inflation this year.
“Contingency plans have been discussed and have been for a considerable time,” King said at a press conference to present the bank’s quarterly Inflation Report today in London. “We are navigating through turbulent waters with the risk of a storm heading our way from the continent.”
Inflation will be about 1.6 percent in two years after staying above the 2 percent target for longer than it predicted in February, the central bank’s forecasts show. Officials also said that U.K. growth is likely to remain “subdued” in the near term, held back by the government’s fiscal squeeze, the pace of the global economy and tight credit conditions.
Policy makers voted to halt expansion of stimulus last week after some officials stepped up their rhetoric on inflation, which has been above their goal for more than two years. King said today that there’s a case both to expand bond purchases or to hold fewer securities and that the risks to inflation are “broadly, evenly balanced.”
“The asset purchases we made between October and last month will continue to stimulate the economy for some time to come,” King said. “The fact we’ve not continued the program at this stage doesn’t mean to say the effect doesn’t continue to pass through the economy - it does - and the option is still open to us also.”
Ten-year gilts extended their advance after the release of the inflation report. The yield fell five basis points to 1.855 percent as of 11:39 a.m. in London. The pound fell 0.4 percent today and traded at $1.5925.
The central bank held its key rate at a record low of 0.5 percent on May 10 and kept its bond-purchase target at 325 billion pounds ($517 billion). Officials said today that despite the changes in the near-term outlook, “the fundamental policy challenges” after the financial crisis and recession have stayed the same.
“There are major problems ahead,” King said. “There are major credit losses to be realized. Whatever happens there will be difficulties ahead that will undoubtedly affect us” and “it is not sensible to think solely in terms of ‘euro stays together - excellent. Euro comes apart - disaster,’” he said.
In the euro area, Greece is headed for new elections after the inconclusive May 6 vote pushed Syriza, which opposes the nation’s international bailout, into second place and reignited concern that the country will renege on pledges to cut spending.
“I don’t think anyone is under any illusion that we’re not all going to be affected by this,” King said. “Our banking system is exposed to the euro area. We certainly are going to be affected.”
According to forecasts published today, gross-domestic- product growth is seen at about an annual 2.6 percent in two years. The bank publishes its quarterly predictions in the form of fan charts without specifying exact numbers. It will release data indicating exact figures next week.
“Concerns about the possibility of a disorderly resolution” in the euro area have “adversely influenced asset prices, bank funding costs and confidence,” the Bank of England said. “The MPC judges it likely that the possibility of such extreme outcomes crystallizing will continue to weigh on U.K. activity for some time, even if those outcomes do not actually occur.”
Reports this month indicated U.K. manufacturing and services weakened in April after the economy shrank 0.2 percent in the first quarter.
Still, inflation concerns are mounting, with consumer price growth accelerating to an annual 3.5 percent in March from 3.4 percent the previous month. Deputy Governor Paul Tucker said April 18 that the “uncomfortably above target” rate could hold above 3 percent into the second half of the year, while minutes of the MPC’s April meeting said there was a risk it may “fall less rapidly” than previously projected. Tucker and Chief Economist Spencer Dale have also highlighted inflation risks.
“Although the expansionary stance of monetary policy should continue to support demand, headwinds from the external environment, tight credit conditions and the fiscal consolidation are likely to persist,” the central bank said in its report. “Inflation is judged about as likely to be below the target as above it by the end of the forecast period.”
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