The Governor of the Bank of England has warned that “it now seems likely” the UK economy is entering a recession.
Mervyn King said the UK faced a “long, slow haul” to repair the economic fall-out from the recent banking havoc.
The banking system faced its biggest threat for almost 100 years after an “almost unimaginable” chain of events set in train by the collapse of Lehman Brothers in September, he said.
In a speech to business leaders in Leeds he said: “Why has the outlook deteriorated so quickly?
“The banking crisis dealt a severe blow to the availability of credit...
“We now face a long, slow haul to restore lending to the real economy, and hence growth of our economy, to more normal conditions”.
A recession looms because the credit squeeze came at a time when disposable incomes were falling due to rising energy and food prices.
Mr King added: “So, taken together, the combination of a squeeze on real take-home pay and a decline in the availability of credit poses the risk of a sharp and prolonged slowdown in domestic demand.
“Indeed, it now seems likely that the UK economy is entering a recession.”
The outlook for the world and the UK economy was “very uncertain” after a “somewhat too exciting” past few weeks, the Governor said.
But the recapitalisation of the banking system – including £37 billion for Royal Bank of Scotland, HBOS and Lloyds TSB will come to be seen as “the moment ... when we turned the corner”, he predicted.
Banks across the world have been hit by losses on toxic debts such as sub-prime mortgages since the credit crunch struck more than a year ago – and dragged economies down with them.
“The actions that were taken were not designed to save the banks as such, but to protect the rest of the economy from the banks,” Mr King said.
He called for patience from banks “batting on a sticky wicket”.
He added: “Let me extend an invitation to the banking industry to join me in promoting the idea that a little more boredom would be no bad thing at the moment.”
He said the bail-outs were bound to raise national debt but he added that the Government should be able to reduce its stake by selling units in a Bank Reconstruction Fund and repaying debt.
The rescues have begun to ease fears in markets, but he warned “the age of innocence” when banks would lend to each other for three months or more at a small premium to expected rates “would not quickly, if ever, return”.