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News - 13 May 2009
Mervyn King. Governor of the Bank of England.

Mervyn King predicts a prolonged convalescence but the City is upbeat

In the latest Bank of England quarterly report growth forecasts over the next two years have been cut and estimates for inflation raised and the Bank has said that the UK economic recovery is likely to be “slow and protracted” but City economists have favourably revised their growth forecasts.

The Bank is more pessimistic than the Chancellor about how quickly growth will recover to normal levels. Governor, Mervyn King said, "The prospects for economic growth remain unusually uncertain, reflecting the exceptional economic and financial factors affecting the outlook,"

The Bank is forecasting a decline in economic growth of about 3.9% in 2009 but a return to growth of about 1% in 2010.

Mervyn King said he saw some reasons for optimism and the pace of economic decline had moderated but he was cautious about problems in the banking sector, which he suggested had not yet been fully resolved.

While City economists don't diagree about the uncertainty over the strength of recovery some leading forecasters are now suggesting the recession will not be as deep as previously thought. Credit Suisse were predicting 2010 growth at 1% but they have amended this figure to 1.8% largely due to the end of inventory rundown (see Economic Partnership comment below).

J.P. Morgan is also more optimistic suggesting that the economy will contract in 2009 by 3.6% (previously forecasting 4%) and 2009 will see growth of 1.7% (previously forecasting 0.5%). Citi Bank is more gloomy but still adjusting forecasts upwards predicting a 3.9% decline this year (previously a decline of 4.1%) and growth of 0.1% next year (previously a decline of 0.7%).

The Bank forecast that (CPI) inflation should fall to around 0.5% by the end of this year before picking up to around 1.2% in two years' time - below the Bank's target rate of 2%.

With interest rates as low as they can go, the Bank has been pumping money into the banking system through “quantitative easing” (printing money to buy government and corporate bonds) to stimulate the economy. A further £50bn was announced in the past few days but it may take 6-9 months before we see evidence of its effects.


On the plus side the economy should be boosted by the unprecedented monetary and fiscal policy stimulus of the last year. The big depreciation of sterling is also an advantage (it has lost 27% of its trade weighted value over the past year - more than at the time of the 1992 ejection from ERM) and the fact that inventories have been left to run down and quite soon producers will have to replenish their stock levels.

On the negative side the recession in the UK (and any recovery) must be viewed against the backdrop of global financial crisis. Companies and households may continue to pay down debt (the savings rate increased to 5% from less than zero in the final quarter of 2008) and the banks will probably continue their cautious approach to lending for quite some time to come.

The extent to which they will pay down debt, and reduce consumption will be an important factor in the recovery. The change in consumer attitude to debt has two drivers –increasing unemployment and a decline in average earnings, which were officially down 0.4% in March compared to the same period in 2008.

But that largely reflects the collapse in bonuses from City institutions. If these are taken out of the equation average earnings are showing an increase of 3% and they are likely to rise again this year as interest rates remain at rock bottom and retail price inflation goes into negative numbers.

Those people in work have rarely been better off and their savings currently get very little interest, which is not a great incentive to keep on saving. Although retail sales have declined over the past year, there has been some surprise that they have not declined further and while big ticket items are certainly not being bought, there are plenty of small ticket retailers that are doing very nicely. Some better than they ever have.

Rising unemployment, increasing housing repossessions and higher taxes next year may yet all conspire to depress consumption further but it is by no means certain.

Even when the recession formally ends, there is still considerable uncertainty about the strength of the recovery and the time it will take to get the economy back on an even keel and while the UK certainly can’t spend its way out of the recession, continued consummer spending will certainly help.

Read related items on:
Bank of England
King, Mervyn

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