LONDON (Reuters) - The Bank of England may need to inject more money into the economy if growth shows clear signs of slowing or if the euro zone crisis has a big impact, BoE Deputy Governor Charles Bean said on Monday.
The central bank was concerned that high recent inflation would drive up price expectations and wage demands, although the main scenario was for inflation to fall back to target in two years, Bean also said.
The economic recovery faced significant risks from the sovereign debt crisis in the euro zone — the UK’s biggest trading partner — as well as heavy government spending cuts at home, he said.
“It is certainly possible that we may well want to undertake a second round of quantitative easing if there is a clear sign that UK output growth and with it inflation prospects are slowing,” Bean told a business audience in London.
“Equally at some juncture it will be appropriate to start withdrawing monetary stimulus. There are risks on both sides.”
“But equally there are very significant downside risks, particularly from the euro zone sovereign debt crisis. If that unfolds in an unhappy fashion, I think it is quite plausible that it would have a significant adverse impact on the UK.
“Under those circumstances, we might well want to undertake a further round of quantitative easing.”
The BoE bought 200 billion pounds of government bonds and corporate debt between March 2009 and February this year and slashed interest rates to a record low 0.5 percent to help pull Britain out of its deepest recession in its post-war history.
The asset purchase programme, also known as quantitative easing, has been on hold since February, and growth has rebounded strongly since then.
Inflation has been above the BoE’s 2 percent target throughout this year, and Bean said policymakers would watch price risks next year closely due to the threat of higher commodity prices and the danger from rising inflation expectations.
However, the moderate pace of growth and the fading effects of sterling’s past depreciation should mute inflation pressures.
Moreover, the economy faced significant challenges in the year ahead, with Britain’s prospects depending on private-sector final demand and net exports, he said.
Bean’s speech was broadly in line with past BoE statements — which point to upside risks to inflation and downside risks to growth — though it highlighted two inflation dangers for 2011 more starkly than usual.
“First ... strong global growth continues to generate upward pressure on the prices of commodities and tradable goods more generally,” Bean said. “Second (there is a risk) that the period of elevated inflation causes medium-term inflation expectations to drift up, leading to higher rates of increase of both wages and prices,” he said.
“We shall be watching these indicators, and their impact on wages and prices, like proverbial hawks,” he continued.
Bean said the risk of a wage-price spiral had risen because inflation had been above target throughout 2010. The BoE does not expect it to fall below 2 percent until 2012, due to a rise in value-added tax planned for next month.
“Rapid recovery in emerging markets has reawakened global inflationary pressures. And here in the United Kingdom, inflation has been running above the MPC’s target for an uncomfortably long time. It may be some while yet before normality is restored,” he said.
However, Bean saw plenty of threats to growth next year that may cause inflation to undershoot rather than overshoot the BoE’s forecasts of over 3 percent CPI for 2011.
Households had probably not finished reducing their spending in response to the recession, public spending would fall and demand for British financial services overseas may continue to be weak.
Overall, though, British banks were well placed to weather direct losses from adverse events in Greece, Ireland, Portugal and Spain and the lower level of sterling should also boost exports of goods.
“Even under a very adverse scenario, (banks) should be able to absorb the likely losses on their direct exposures to Greece, Ireland, Portugal and Spain without too much difficulty. There is, though, the possibility of further indirect effects ... which could amplify the impact,” Bean said.
Writing by Fiona Shaikh; Editing by Ron Askew