European News

09, Mar 2010.

Bank of England policy maker Kate Barker said she is optimistic that the U.K. economy is recovering and that it faces fewer threats than before.

“There are grounds for optimism from recent data that the recovery is broadly on track,” she said in a speech to the National Institute of Economic and Social Research in London yesterday. “I don’t think it is yet possible to be confident in the pace of recovery and still expect the path to be bumpy. But some of the severe downside risks have diminished.”

The bank’s 200 billion-pound ($301 billion) bond-purchase program has helped the economy rebound by cutting credit costs, supporting asset prices, and buoying confidence, she said. The central bank kept the plan’s size on hold for a second month last week as officials judged the strength of the recovery.

“I don’t consider the evidence suggests that this rise in asset prices has gone too far and therefore do not believe that this has become another risk to future economic stability,” Barker said. “My concern is that this channel might become less powerful if quantitative easing were to be extended, as confidence effects might be less apparent, and there might be reluctance to engage in further portfolio rebalancing as the price of risky assets rose.”

The U.K.’s benchmark FTSE 100 Index has risen 60 percent from the six-year low of 3512.09 reached March 3 last year, and it touched the highest since September 2008 last week. British house prices were up 4.5 percent in February from a year earlier, according to Lloyds Banking Group Plc’s Halifax unit.

Interest Rate

Barker said the asset-price rally doesn’t suggest the central bank has stoked the seeds of another crisis by keeping policy too loose. The bank decided last week to keep the benchmark interest rate at a record low of 0.5 percent.

Risks to economic growth include “a continuing weakness in the world economy, particularly the EU,” while “credit conditions also remain a concern,” she said. “Despite the speed with which bank rate was cut to 0.5 percent in late 2008 and early 2009 and the rapid move to quantitative easing, the economy is still looking fragile.”

Barker said the Monetary Policy Committee’s task of meeting the 2 percent inflation target without undermining the recovery could be advanced by extending the horizon for policy judgments. She said this could be done without undermining Britons’ expectations for inflation, which reached a 14-month high of 3.5 percent in January.

Inflation Target

“Inflation could be a little below target at the two-year horizon,” she said. “However, the present above-target inflation background suggests little cause for anxiety about inflation expectations becoming de-anchored on the downside if the MPC were to suggest it might take a little longer to move the underlying inflation trend back to target.”

Slow growth in Britain’s trading partners may pose a drag to the economy’s rebalancing toward exports, she said. Manufacturers haven’t benefit much from a weaker pound, even after sterling fell by about 25 percent in the last three years against a trade-weighted basket of currencies, she said.

“Slow growth elsewhere would make it more difficult for the U.K. to achieve an improvement in the external balance,” she said. “The U.K.’s external sector has so far perhaps had a rather disappointing response to the depreciation of sterling. Manufacturing output has not, so far, performed any better in the early stages of recovery than has the U.S., Germany or France.”

Constraints on government spending may also slow the return to growth, she said. Prime Minister Gordon Brown and the opposition Conservatives have placed measures to tame the record deficit at the center of their campaign for an election due by June. The budget gap is set to exceed 12 percent of economic output this year.

“With the public sector now seeking to reduce its own deficit, concern over likely improvement in the U.K.’s external balance would suggest that a fast recovery in the U.K. would only be possible if the household and corporate sector balance sheets were to deteriorate,” Barker said.