King’s Inflation Report gives pessimistic view for UK economy

15 November 2007
The UK will need two rate cuts to counteract economic slowdown, and inflation will fall below its target in two years time if the cuts are not made, said Bank of England governor Mervyn King in the most pessimistic inflation report for several years.

Mr King expects the global credit squeeze to have a significant impact on UK growth next year, and that falling share prices and currency turbulence would pose further risk to the country’s economy. Analysts have taken these remarks as a sure sign that rate cuts are on the cards in the near future.

The report’s pessimistic outlook had bad tidings for credit conditions, which will tighten for households and companies, making borrowing more expensive but encouraging households to put more emphasis on savings and less on borrowing. “The effective rates on both secured and unsecured loans continued to rise gradually in the three months to September” and “Conditions appear to have tightened most for households with adverse credit histories.” the report said.

Consumer spending, however, “has maintained momentum despite the increases in Bank Rate since August 2006 and subdued income growth”.

The governor used the situation in the US as an example of the adverse effects of the sub prime crash and subsequent credit crunch, and to bring home fears that a similar situation could develop in Britain. In America, the prospect of a teetering economy is not merely hypothetical, but is being played out now and is a major concern for the UK economy.

Meanwhile, the US Federal Reserve is taking a leaf from the Bank of England’s book, and plans to overhaul its system in order to more effectively communicate with the markets and the public by revealing the economic outlook in a quarterly report, with a more frequent, detailed, and long-ranging forecast, whereas currently such information is only released biannually.

The crisis has also exposed the weaknesses of the UK’s tripartite system of regulation – consisting of the Financial Services Authority, Bank of England and the Treasury. Consequentially, the FSA has announced plans to reform the system which left consumers in the dark about whether or not their money was safe in the wake of the run on Northern Rock. Following America’s lead to take inspiration from the British system, UK regulators have decided to bring in reform which mimics that of the US Federal Reserve, which provides customers with a guarantee that their money is secure.

Various scapegoats have been named as being responsible for the credit crunch; most prominently, blame has been directed towards reckless attitudes towards debt and risk among the world’s leading financial services providers.

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