The Bank of England will probably have to ease monetary policy further to get the British economy growing again and inflation back up to target, possibly by buying gilts to boost the money supply, Governor Mervyn King said today.
Interest rates did not have to fall to zero first, he said, signalling that the BoE's Monetary Policy Committee could vote to start quantitative easing - where a central bank raises the monetary base to support the economy - as soon as next month.
Mr King unveiled the BoE's quarterly Inflation Report which forecast inflation at just 0.5 per cent in two years, and staying below its 2 per cent target in all that time.
“The (BoE's new) projections imply that further easing in monetary policy may well be required. That is likely to include actions at aiming to increase the supply of money in order to stimulate nominal spending,” he told a news conference.
Taking such unconventional measures would almost certainly include buying gilts, he said, lighting a fire under the March gilt future which shot up by nearly 2 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 after the BoE cut them by 50 basis points to a record low of 1 per cent last week.
The economy is expected to shrink substantially in 2009, perhaps by a rate of as much as 4 per cent in the early part of this year. Growth only resumes at the end of the year but the risks were weighted substantially to the downside.
Risks to the inflation forecasts were also slightly to the downside as the recession could last even longer than the BoE forecast.
King said the BoE forecast for economic output was probably gloomier than others but he said that recovery would eventually come as there was already a lot of stimulus in train.
Sterling had fallen sharply, commodity prices were lower and rates had already fallen by four percentage points since October, he said.
The BoE forecasts assume rates falling to a trough of 0.7 per cent in the third quarter and only rising to just over 2 per cent at the end of next year. GDP is seen falling for most of this year before recovering at the end of the year.
Reuters