A brutal, but brisk, recession is the prospect projected by the Bank of England in its latest quarterly “inflation Report” yesterday, coupled with a warning that the lack of historical parallels makes such predictions highly uncertain.
Asked whether the official Bank Rate might fall below the previous nadir of two per cent, the Bank’s governor, Mervyn King, refused to rule out the possibility that it could fall to zero, as in Japan in the early 2000s.
“We are certainly prepared to cut Bank Rate again if that proves necessary,” he said.
He went on to suggest that the cost of living as measured by familiar Retail Prices Index will very likely be falling in 2009.
“It is very likely that the RPI will go into negative territory next year,” Mr King said. This was because interest rate cuts would feed through to mortgage interest, which features in the RPI, but not in the Consumer Prices Index, the benchmark for the Bank’s two per cent inflation target.
The Bank expects the CPI to fall so sharply from its peak of 5.2 per cent in September that it slides below the target around the middle of next year, then go on falling to a little under one per cent.
The Bank’s central projection for growth shows the British economy in a year-on-year decline of some two per cent by next spring before picking up sharply until it is all square this time next year.
Something approaching a boom could then develop, carrying growth back above its long-term trend of 2.5 per cent by early 2011.
Mr King presented these projections with emphatic health warnings, pointing out that the banking crisis following the collapse of Lehman Brothers was the most serious since the outbreak of the First World War in 1914.
They also allowed nothing for the tax cuts and boost to public spending in the Government’s “fiscal stimulus” expected in Chancellor Alistair Darling’s Pre-Budget statement set for November 24. “As a result, the fan charts (illustrating the Bank’s projections for growth and inflation) exaggerate the extent to which the (monetary policy) committee believes output will decline and inflation will fall below target in the medium term,” Mr King said. He also held out the prospect of a rapid recovery as actions by central banks and governments round the world take effect.
“We are moving into very difficult times and people should be concerned we are moving into those difficult times, but that is not to say we won’t come through it,” he said.
Mr King accepted that it was “perfectly OK” in the present circumstances for the Government to breach the fiscal rules imposed by Gordon Brown in his early days as Chancellor – provided that the boost was temporary and presented with a medium-term plan to restore the public finances.
David Kern, chief economic adviser to the British Chambers of Commerce, noted “a distinct possibility that we will face temporary deflation”.
He added “It is important that the MPC perseveres with interest rate cuts over the next few months. We expect rates to come down to two per cent in 2009, and there is a strong case for reducing rates further to 1.5 per cent or even one per cent in the middle of 2009.”