Bank says UK 'in deep recession'

By Steve Schifferes
Economics reporter, BBC News

Bank of England governor Mervyn King warns about the economy

The governor of the Bank of England, Mervyn King, has warned that the UK is "in a deep recession" in 2009 and said rate cuts may no longer work.

In its latest forecast for economic growth and inflation, the Bank says that the UK economy will decline sharply in the first half of the year.

And it says that there is a significant risk that the recession will be even longer and deeper than expected.

The Bank forecasts the economy will shrink by 4% from mid-2008 to mid-2009.

Restoring both lending and confidence will not be easy and will take time Mervyn King, governor, Bank of England Recession tracker Flanders: From Optimism to Pessimism

The governor gave a strong hint that the Bank will have to consider "unconventional measures" to boost the amount of money in the economy in the near future as interest rate cuts have been less effective.

Its central forecast suggests a decline of around 3% for the whole of 2009, followed by a sharp recovery with positive growth in 2010.

But the length and depth of the recession will be dependent on the world economy, Mr King said, with the risks still "significantly on the downside."

Trade contracting

The Bank's forecast for 2009 is noticeably more gloomy than many others, and is a particularly sharp revision of its own forecast just three months ago.

Mr King pointed out that since the Bank's last forecast in November, a severe economic downturn had taken hold around the world.

"Growth in the advanced and emerging market economies fell sharply towards the end of last year. And world trade is contracting rapidly," he said.

The slowdown could be deeper if "the authorities at home and abroad are only partially successful in improving the availability of credit and restoring business and consumer confidence".

The Bank also said that inflation would remain below its 2% target by the end of its two-year forecast period.

But business leaders are even more pessimistic.

David Kern, chief economist at the British Chambers of Commerce said that the Bank's forecast for a recovery by 2010 "seems unduly optimistic."

And Graham Leach, of the Institute of Directors, added that "we are well into the financial crisis but the economic crisis is only just beginning."

New policy options

The Bank of England has already cut interest rates from 5% to 1% in the last five months in a bid to stimulate the economy - and made it clear that it is ready to consider more unconventional measures.

The governor said that the efficiency of further rate cuts was now "somewhat impaired" and hinted that new measures might be introduced soon.

Mr King said that the "Monetary Policy Committee can and will take action to return inflation to the target and so ensure that economic growth will again match its potential".

He indicated that as well as interest rate cuts, the Bank was ready to use a wider group of policy measures to increase the money supply, thus easing conditions in the economy, including using a new £50bn facility to buy up distressed commercial and corporate assets.

But he said in the future, the Bank could buy government bonds - or gilts - directly in order to help increase the amount of money in the economy.

In the US, the Federal Reserve has also hinted at taking such action, but appears to have recently pulled back from the direct purchase of US government debt.

But under a plan announced on Tuesday, the US central bank and the Treasury plan to spend up to $1 trillion to buy up distressed consumer credit assets to help boost spending.

Will it work?

Mr King said he was encouraged by the co-ordinated policy responses around the world, but admitted that "the prospects for economic growth remains unusually uncertain, not least because of the extraordinary events of the past few months".

The big problem is how quickly credit markets will return to normal, and whether business and consumer confidence will recover.

Mr King admitted that the further tightening of credit markets had made monetary policy less effective.

And he said that the "collapse of confidence, or 'animal spirits' in Keynes' description, is leading to falls in production and output".

"Restoring both lending and confidence will not be easy and will take time," he added.

In particular, it can take up to 18 months for the economy to respond to changes in monetary policy - even without the credit problems.

But he insisted that the unconventional monetary policy measures were not new, but were tried and tested.

World problem

The Bank of England is hoping that the UK economic recovery can be driven by "rebalancing the economy" towards exports and investment instead of consumption, helped by the fall in the value of the pound.

But given the severe problems in credit markets, as well as rising unemployment which is reducing demand for goods, the UK recovery will be unusually dependent on conditions in the world economy.

Mr King said there was still a need for urgent co-ordinated action on a worldwide scale to help the recovery.

This could include action at the G20 summit in April to give more powers to the IMF and World Bank to strengthen the world financial system, and greater obligations on countries with trade surpluses -like China - to boost their economies.

However, a recent survey by the IMF suggested that there are still wide differences among the rich countries in how far they are prepared to go in stimulating their economies.