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WOTTON-UNDER-EDGE, England (Reuters) - The Bank of England must take urgent steps to stimulate the sluggish economy and should work with the government to set up a new bank to boost lending to smaller companies, Bank policymaker Adam Posen said on Tuesday.
Posen, a lone voice on the bank's nine-man rate-setting committee in calling for more stimulus since last October, repeated his long-standing argument for more asset purchases but said more must be done to bolster the sluggish economy.
"Unfortunately the underlying economic situation in the UK and throughout the G7 is that serious," he said in a speech in Wotton-under-Edge, a market town in southwest England. "That central banks have failed to take sufficient additional stimulative action over the last year has made the prospects worse."
The economy has barely grown since last September. and the recent slump in share prices and the global economic cooling have triggered fears of a renewed recession. Central banks around the world have not moved far enough towards more easing, Posen added.
The Bank should start with 50 billion pounds of gilt purchases "tilted towards the longer end of the maturity spectrum" over the next three months, he added. Failing to act now will change the UK economic outlook "from grim to grimmer."
The central bank has left interest rates unchanged at a record low of 0.5 percent and also kept its stock of asset purchases unchanged at 200 billion pounds this month.
The Bank of England and the government should co-operate to boost lending to small- and medium-sized enterprises (SMEs) and new businesses, Posen said. The government could set up two new public bodies to narrow the investment gap by increasing credit availability.
One would be a public bank or authority for lending to small business. The other would be an entity to bundle and securitise loans made to SMEs, which Posen suggested calling the British Enterprise Investment Equity, or 'Bennie'.
The Bank could then purchase more gilts on the secondary market, effectively financing the SME bank.
"The Bank could then commit to discounting the securities from Bennie ... and, as needed, various loans and other assets from the new SME bank," he said.
Posen estimated that the existing investment gap, caused by a lack of lending, amounts to 2-3 percent of national output, or about 60 billion pounds. The central bank and the government could set up a new bank within a year to boost lending to smaller companies, possibly with the help of banks that are part-owned by the state, he said.
The last government took stakes in two of Britain's biggest lenders, Lloyds and Royal Bank of Scotland, to bail them out during the financial crisis.
The current Conservative-led coalition is keen to foster more competition in the British banking sector and has talked of a new "challenger bank" to stand alongside the existing lenders.
Britain will impose the world's toughest banking regulations under proposals laid out this week by a government-backed commission that looked into sweeping reforms of the industry.
Editing by Ruth Pitchford