The Governor of the Bank of England, Mervyn King, said Tuesday that the British economy is slowly emerging from its deepest recession since World War II but that inflation, which fell in August to a near five-year low, was unlikely to be a problem any time soon.
“Falls in output have broadly come to an end and we are beginning to see some very small signs of positive growth,” said. Mr. King in testimony to an influential group of lawmakers. In the first quarter of the year, the British economy shrank by a massive 2.4 per cent, followed by 0.8 per cent contraction in the second.
He said the improvement has been largely due to firms de-stocking at a slower pace, a weaker pound and extraordinary measures from the Bank of England — such as slashing interest rates to a record low of 0.5 per cent and buying nearly 150 billion pounds of financial assets from banks.
However, he stressed that the growth rebound in Britain and abroad was “very small” in comparison with the sharp fall in output that preceded.
“There is a long way to go before the level of output gets back to where it was,” said Mr. King. “Growth rates don’t tell the story, it’s the levels that matter.”
Mr. King’s comments have come amid mounting optimism about the British economy, with figures pointing to a stabilisation in the housing market, marked improvements in consumer confidence and a resumption of growth in the manufacturing sector.
Despite signs of a modest turnaround, Mr. King appeared fairly optimistic about inflation remaining subdued as the recession had opened “significant spare capacity” in the economy.
Mr. King said inflation was likely to remain volatile over the next year — in the next six months, he said inflation would likely fall further below the current level before rising above the target.
Over the medium-term, Mr. King said inflation was more likely to undershoot the 2 per cent target than rise above it, especially as the strength and sustainability of the recovery is highly uncertain.
His comments came after the Office for National Statistics reported that consumer price inflation fell to 1.6 per cent in the year to August — its lowest since January 2005 — from 1.8 per cent in the previous two months, largely because of lower food costs and domestic energy bills.
However the fall was not as big as expected and may hint at some price stickiness in the economy, analysts said. The consensus in the markets was for inflation to fall to 1.4 per cent.
Ross Walker, an economist at the Royal Bank of Scotland, noted that in 2009 inflation has come in above forecast on five occasions, in line twice and below just once.
“We do not believe that Britain has an inflation problem, but the degree of further policy loosening that can be justified given these inflation data is increasingly open to question,” he said.
Mr. King insisted that it was the outlook for inflation that will guide when and how the Bank of England’s rate-setting Monetary Policy Committee raises interest rates back towards more normal levels, and when and by how much the financial assets bought since March are sold.
A more detailed look at the inflation figures showed inflation was dragged down by falling food prices and unchanged household energy bills, which did not see the same big hikes as 12 months earlier.
However, second-hand car prices rose 2.2 per cent over the month and are now 4.4 per cent higher than a year ago —the highest ever annual increase since records began in 1997.
Though the headline rate continues to benefit from the fall in oil prices from July 2008’s peak of $147 a barrel, analysts joined Mr. King in warning that it may start to edge higher again in the coming months as the oil price changes fall out of the annual comparison and the government reverses its cut in sales taxes.
“Higher petrol prices and the reversal of the value added tax cut will push it up again around the turn of the year,” said Vicky Redwood, economist at Capital Economics in London.
Mr. King also sought to dampen the mounting optimism about the banking sector, noting that lenders will be burdened with loan-related losses for years to come at a time when it should also be raising capital buffers to prevent another crisis.
Mr. King confirmed that the Bank is considering cutting the interest rate for deposits held by banks to dissuade them from storing up cash. He said a lower deposit rate “could make the banks work a little bit harder” to convert their reserves into other assets.
Concerns have grown that the pressure for banks to hold on to cash to bolster their balance sheets has lead them to hoard the extra money being pumped into the market by the Bank of England rather than passing it on to borrowers.