Bank warns government to control fiscal policy

By Matt Falloon

LONDON (Reuters) - Bank of England Governor Mervyn King warned the government on Thursday not to allow its spending to get out of control or start underwriting new mortgage lending as the country nears its first recession since the early 1990s.

The Labour government, well behind in opinion polls to the Conservatives and expected by many analysts to lose the next election due in 2010, is under growing pressure to ramp up spending to help households cope with the economic downturn.

Chancellor Alistair Darling has said the government can allow borrowing to rise, but King said that failing to keep fiscal policy credible could make the central bank's job harder.

"The long-term risk is a fiscal framework that is not perceived by financial markets to be credible does put up pressure on inflation expectations because it undermines the market's belief in the credibility of both the monetary and the fiscal framework," King told parliament's Treasury Select Committee.

"And that will make our life more difficult if inflation expectations were to remain higher than we would wish."

Many analysts expect government borrowing for this financial year to overshoot Darling's 43 billion pound forecast and the Institute for Fiscal Studies has criticised the government for leaving little room to manoeuvre if the downturn worsens.

There has also been speculation that the government could justify higher spending or tax cuts by raising its self-imposed limit of keeping public debt below 40 percent of Britain's gross domestic product over the economic cycle.

FISCAL WARNING