Page last updated at 05:14 GMT, Thursday, 19 June 2008 06:14 UK

Bank governor offers bleak view

Mervyn King on take-home pay

The UK faces its "most difficult economic challenge for two decades", the Bank of England governor has said.

Mervyn King was speaking at the Mansion House dinner and made it clear that inflation was set to rise, while growth and house prices were likely to fall.

Mr King also warned that real take-home pay would stagnate, making life difficult for some families.

His words came as Chancellor Alistair Darling said the Bank would have new powers over UK financial stability.

This would be in addition to its objective of setting interest rates, he told the annual dinner of business leaders.

It has also emerged that Sir John Gieve is to stand down early as Deputy Governor of the Bank of England.

'Not an easy time'

Mr King said that the Bank had the "right framework" to make sure inflation returned to the government's 2% target and that economic growth recovered.

He said the Bank's rate-setting Monetary Policy Committee (MPC) was "prepared to take whatever action is needed" to bring inflation down.


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The BBC's economics editor Hugh Pym said that this meant "in other words, interest rate rises couldn't be ruled out".

But Mr King added that no monetary policy could prevent the current effects of rising food and energy prices on living standards.

Neither could interest rate cuts coax banks, which are currently re-evaluating risk and keeping a tight grasp on their balance sheet, to be more generous in their lending to house buyers.

And he warned that higher living costs were likely to restrain consumer spending to a far greater extent than tighter lending conditions as a result of the credit crisis.

"It will not be an easy time, and I know that some families will find it particularly difficult," he warned.

These predictions were echoed by Adrian Coles, of the Building Societies' Association.

He said it would be "the first time in about 10 or 12 years that we've had no increase in real pay", prompting him to conclude that "people are really going to notice a difference in the economic environment".

Mr King also warned that "the era of cheap mortgage finance that underpinned the housing market in 2006, and the first half of 2007, is over".

'Act decisively'

In his first speech to the annual dinner, the chancellor emphasised the need to tackle inflation, although he pointed out that the current rate of 3.3% "remains low" compared to the 1970s "when it reached over 26%".

Mr Darling said the new powers given to the Bank would see a new Financial Stability Committee set up to guide the Bank's operations in this field.

"It will bring valuable, external expertise with City experience to bear on the Bank's decision-making," he said.

"The challenge for us is to ensure that the authorities can act quickly and decisively where necessary to support financial institutions," Mr Darling added.

Alistair Darling talks about the Bank's new remit

He intimated that the proposals would clarify and enhance the powers of the Bank of England and the UK financial watchdog, the Financial Services Authority, in addition to improving co-ordination between the regulators.

More details will come in a letter to the Treasury Select Committee chairman John McFall on Thursday.

Mr Darling's stance was upbeat, arguing that the UK would continue to grow despite "global difficulties".

He said: "Independent forecasters expect UK inflation to fall back next year.

"Employment is at a record high. Many order books are full. British business is competing and winning all over the world. Our economy is flexible and resilient."

Pay deals

As part of his strategy to tackle consumer inflation, Mr Darling again called for pay restraint in both the private and public sector.

Shadow chancellor George Osborne told the BBC he was against reopening public sector pay deals and was in favour of wage restraint.

"What the government should be doing is stopping the tax rises that are adding to the cost of living," he said.

Meanwhile, shadow chief secretary to the Treasury Philip Hammond called the chancellor's speech a "missed opportunity".

"What Britain needed from the Mansion House speech was a display of economic leadership. Instead all we got were rehashed announcements and no new ideas," he said.

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