LONDON (Reuters) - The Bank of England will probably have to ease monetary policy further to get the economy growing again, and could start buying gilts as soon as next month to achieve that, Governor Mervyn King said on Wednesday.
New forecasts from the central bank showed inflation at just 0.5 percent in two years, well below the 2 percent target, even with interest rates already at a record low of 1.0 percent.
The economy, already in its first recession since the early 1990s, is expected to shrink rapidly over 2009, growing again only towards the end of the year.
“The projections imply that further easing in monetary policy may well be required. That is likely to include actions aimed at increasing the supply of money in order to stimulate nominal spending,” King told a news conference.
He said such an unconventional measure — known as quantitative easing and practised with mixed results in Japan in the early part of this decade — would almost certainly involve buying UK government bonds, known as gilts.
That was enough to light a fire under the gilt market. The March gilt future made its biggest one-day gain on record, rising more than two full points.
The pound tumbled and short sterling interest rate futures rose as markets had expected a much more hawkish set of forecasts. Many analysts had thought that interest rates might have already hit bottom last week.
“The scale of the forecast downturn is breathtaking. And, the inflation forecast is so low for so long that it clearly signals further scope for monetary loosening,” said Michael Saunders, economist at Citigroup. “The message that policy will need to be loosened further could not be clearer.
Forty seven out of 52 analysts polled by Reuters after the report was published now expect the BoE to cut rates at its March meeting. They ascribed an 80 percent chance of the central bank engaging in quantitative easing, in March or April.
Despite King’s forthright comments at the news conference, there was little in the Bank report to suggest that such easing was imminent — a sign perhaps that not all Monetary Policy Committee members shared the governor’s view or that King’s had added the remarks at the last minute.
King said that interest rates did not have to go down to zero before the Bank started quantitative easing, effectively printing money. At their current level, it did not make that much difference if they went down that much further.
The U.S. Federal Reserve has already cut rates to 0-0.25 percent and engaged in its own form of credit easing. Rates in Japan are also at just 0.1 percent and the European Central Bank looks sure to cut euro zone rates to a record low next month.
The length of the recession in Britain, King said, would depend largely on developments in the rest of the world.
Figures out before King spoke showed the number of people claiming jobless benefit rose by 73,800 to 1.233 million in January, its highest level in nearly a decade.
Experts say hundreds of thousands more will lose their jobs this year as the recession takes its toll.
Asked to explain how he could have got policy so wrong, costing the economy so dear, a visibly tetchy King said he did not accept the premise of the question. “It’s not sensible for anyone to pretend they can forecast the future when unexpected events occur,” he said.
Recovery, he said, would come eventually as there was already a lot of stimulus in train. The past rate cuts, the fall in sterling and commodity prices, the easing of fiscal policy would all provide a significant boost to demand.
“So let me assure you that, with the full range of instruments at its disposal, the Monetary Policy Committee can and will take action to return inflation to the target and so ensure that economic growth will return to its potential,” he said.
additional reporting by David Milliken, Matt Falloon and Jonathan Cable