James Saft, Reuters Columnist
First – growth and inflation are falling sharply, with zero growth expected this year and every chance inflation over the medium term will fail to hit the Bank of England’s 2% target.
Second – the BOE is both puzzled by this and intends to do very little about it.
Third – the BOE doubts, in some respects, the value of the steps it could take.
This simply goes to show the limits of monetary policy during a massive global deleveraging, especially one, like our own, in which banks are being kept on life support rather than allowed to sink or float on their own merits.
“We will get back but it’s quite impossible to know over what time period. There is no historical precedent of an event of this kind leading permanently to the end of economic growth and I don’t think it will here either,” King told reporters, but added: “There is still a long way to go”.
The bank’s forecasts have certainly come a long way in a short time. In May it was predicting 0.8% growth for the year. Its mid-range forecast for inflation now shows it below the 2% target for most of the next three years, a figure that takes as an input a market assumption of one more cut in rates next year, from 0.5% to 0.25%.
Even King is not so sure this will help: “I don’t think a change in Bank rate is going to make much of a difference. It’s going to be more counterproductive than not at this point.”
He expressed concern that lower rates would hurt margins at some banks, further impairing them and theoretically making loans, already scarce, that much harder to get. That’s because many loans in Britain are tied to the official rate, but bank funding in the markets, rather than tracking the base rate, is being driven by perceptions of bank risk. Monetary policy transmission is impaired, and gets worse every time markets begin to worry more about the state of the euro zone.
High debts, high pain
That makes more quantitative easing a more likely outcome, but neither the report nor the press conference gave the impression that much was on the way.
There is also the question as to how effective QE has been and can be. The BOE is extremely reluctant to infringe on government’s right to run fiscal policy, and so direct Zimbabwe-style financing of the deficit seems unlikely. While it is debatable how much of a buffer QE has provided, the fact remains that growth since the onset of the great financial crisis has been abysmal in Britain. A Bank of England study from earlier this year maintains that QE has pushed rates down by about 150 basis points and increased asset values by 20% over what they already would have been, implying a peak impact on real GDP of about 2% by the middle of 2011.
That’s impressive, but only underscores exactly how difficult Britain’s position is. It is in the midst of an austerity which is certainly making things worse in the near term. Moreover the size of its debts, public and private, and the composition of its economy make it particularly vulnerable.
On a total debt-to-GDP basis Britain is carrying a heavier load than Spain and Greece, much less the U.S. Its financial sector, which is much too large for its economy, desperately needs to shrink, both because the rest of the world is no longer interested in providing it with cheap funding, and as a matter of safety for the economy. While its manufacturing sector has done well recently, the threat of a euro-led slowdown in global demand is real. Households too are neck deep in debt and not able to serve as the engine of growth.
To be sure, Britain is no Greece or Spain. It has its own currency to devalue, and its own central bank to serve as a lender of last resort. That makes a euro-style financing crisis less likely. It does not make the road back to sustainability all that much less long.
Britain isn’t just trying to come to terms with its own debt burden and banking system, it is trying to do it while the rest of the world does the exact same thing.
Growth and inflation may be subdued for longer than the Bank of England forecasts.
(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. E-mail: jamessaft@jamessaft.com)