Please don't expect sustained inflation, Bank of England deputy wimpers

Bank of England Fears Largest Peacetime Liquidity Crisis

By Angela Monaghan
The Telegraph, London
Tuesday, February 26, 2008

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/02/26/bcnlom...

The Bank of England's deputy governor today warned that the ongoing credit crunch had left the Monetary Policy Committee uncertain as to its next move as it and fellow central banks face up to what she described as the "largest ever peacetime liquidity crisis."

Addressing the Institute of Economic Affairs, Rachel Lomax said that the credit crisis that erupted last summer was still evolving, with a new problem surfacing on a weekly basis. She said: "Each week seems to highlight some new dimension of the ensuing disruption to core financial markets.

"Clearly the situation is still developing. And its impact on the wider economic outlook -- global and domestic -- will depend critically on what happens from now on. Here there are some major uncertainties."

Ms Lomax said that while a correction of the financial markets, after a prolonged period of "plentiful liquidity" and insufficient risk management, had been expected by the bank, the timing and extent had not.

It was, she said, impossible to predict how much the value of assets beyond sub-prime mortgages would be impaired after this particular cycle had run its course.

"Many people -- including the Bank of England -- foresaw that some form of correction in financial markets was highly likely, even inevitable.

"But it was another matter altogether to predict the precise nature and timing of the present crisis. The extent of the reverberations across different markets was certainly not fully appreciated," she said.

She reiterated the comments Governor Mervyn King made in the bank's quarterly inflation report two weeks ago, in which he warned that rising inflation was likely to prevent the Monetary Policy Committee from slashing interest rates.

The risk, she said, was that a short-term spike in inflation caused by higher energy, food, and import prices will lift inflation expectations and therefore affect the medium-term behaviour of price and wage setters.

That, in turn, would limit the bank's ability to cut interest rates as much as it would like in order to try to restrict the downside risks to growth.

Explaining the balancing act, she said: "If price and wage setters do recognise that the imminent pickup in inflation will be short-lived, then the implications of the spike for monetary policy, and for the necessary balance of demand versus supply, should be limited.

"But if price and wage setters start to expect higher inflation to persist, then the committee will need to restrain demand, and so generate some slack in the economy, in order to bring inflation expectations, and inflation itself, back down."

The dual considerations of a downturn in growth and rising inflation were echoed in the CBI's latest Distributive Trades Survey out today, which said that while high street spending had slowed gradually since last April and was "very subdued" this month, prices have risen strongly.

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