By Larry Elliot
Rising inflation and weak house market over next year, says King.
The governor of the Bank of England issued a stark warning yesterday of a looming economic slowdown as he signalled that the next year will be the toughest for Britain in a decade.
Putting investors on high alert for a sharp fall in share prices, Mervyn King said the period ahead would be marked by slower growth, rising inflation, a weakening housing market and a falling pound. He expressed surprise that global stock markets had so-far shrugged off evidence of the slowdown.
The governor stressed that even the two quarter-point cuts in interest rates pencilled in to the Bank’s forecasts would not spare consumers from a painful period of belt-tightening next year – and that the risk was that the UK economy would be even weaker than Threadneedle Street currently expects.
Delivering the Bank’s quarterly inflation report, he made clear his belief that it will be 2009 – the likeliest date for a general election following Gordon Brown’s decision not to go to the country this month – before growth picks up and inflation is brought under control. With oil prices close to $100 a barrel and food prices up by 10% in the last three months, he hinted it would be some time before the Bank responded to economic weakness by cutting the cost of borrowing.
He said the Bank’s “central outlook for the UK economy is, in the near term, one of slowing growth and rising inflation. But further ahead that outlook is for a return of growth to its average rate and inflation to target.”
King stressed that the period of financial market turmoil that led to the run on Northern Rock was far from over and would be intensified by a tumble in share prices.
“It’s very striking that despite developments we’ve seen in the last three months, equity prices are on average higher now than they were in August. This is true around the world and in emerging markets, they’re 20% higher,” King said.
In the City, the FTSE 100 index responded to a rise of more than 300 in New York’s Dow Jones Industrial Average on Monday by jumping almost 70 points to 6432.1 points. King said a fall in equity markets could have a bigger impact on the world economy than the recent credit squeeze.
Threadneedle Street’s nine-strong monetary policy committee raised interest rates five times between August 2006 and July this year, and King said this – coupled with tougher borrowing conditions imposed by lenders in the wake of the credit crunch – would spell the end of the UK’s recent property boom.
“With house price inflation easing and commercial property prices falling, residential and commercial property investment are likely to moderate, possibly quite sharply. And with tighter credit conditions in the future, the personal saving rate is likely to rise, bearing down on consumer spending.”
King also warned that the pound would need to fall in order to boost exports and to close the UK’s £7bn a month trade deficit in goods. Despite its recent strength against the dollar, sterling hit a four-year low against the euro yesterday at €1.4017.
City economists said the gloomy tone of the inflation report hinted at rate cuts early in the new year.
King gave no hint that interest rates would be cut soon, pointing out that the Bank remained concerned that dearer energy and food would prompt higher pay demands and the start of a wage-price spiral. “In comparison with August, the near-term outlook is less benign for both inflation and growth. Last week, the MPC judged that it was appropriate to leave bank rate ahead. There will be some difficult decisions in the months ahead.”