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Setting a course for sustainable growth in 2010

The Bank base rate must remain low and monetary policy loose to encourage strong economic recovery

The Bank of England announced in February that it would not extend its £200bn asset purchase programme but left the door open for more quantitative easing if economic conditions deteriorate further.

The Bank’s Monetary Policy Committee also left the base rate at 0.5% as expected. Almost all analysts had predicted a pause in the quantitative easing programme after 11 months of pumping money into the economy. So that’s probably it for the initiative. mostly gilts, last March with newly created money in an effort to boost the economy.

Most professionals agree that the recovery from recession will be gradual and there’s a lot of spare capacity in the economy. This means inflation is likely to remain below target for a while.

The jury is still out on whether quantitative easing has worked. Critics note that gross domestic product grew by just 0.1% in Q4 2009 after six quarters of negative performance that wiped out 6% of national output and left us as the last major economy to climb out of recession.

But supporters of the programme suggest the outcome would have been much worse if the Bank had not acted in this way.

There is a possibility that the pause in quantitative easing will be accompanied by measures to get the funds the Bank has pumped into the system work more efficiently.

For instance, a cut in interest rates paid by the Bank on commercial banks’ reserves or some form of reserve-targeting similar to the policy framework that existed before the credit markets seized up in 2007 could be seen as a form of monetary loosening.

The worry is that low credit supply along with a restrictive fiscal policy may hold back spending

Some lead indicators are pointing to a robust recovery. For example, purchasing managers’ indices are consistent with GDP growth in excess of 2% year-on-year.

But I am concerned that such figures are a tad optimistic.

Recent retail sales numbers have been disappointing, as have measures of consumer confidence, while some important indicators remain poor.

Household indebtedness is still about 160% of disposable income while incomes are under downward pressure due to a weak labour market and high taxes.

I expect gross disposable incomes to be flat in 2010, which means consumer spending growth could stall unless the savings ratio starts to fall again.

Government spending is likely to contract this year, which will place a heavy emphasis on trade and investment to generate GDP growth.

Fiscal consolidation will intensify whoever wins the general election and in a weak growth environment the likely result is that interest rates will be kept low to compensate.

So rather than seeing the base rate rise to 5% or 6% as in previous cycles, the peak this time round could be closer to 4%.

I’m cautious about the sustainability of the recovery, mainly due to the low supply of credit and the likelihood of restrictive fiscal policy holding back consumer spending.

The Bank should keep interest rates low and its monetary policy loose this year to boost growth, assuming inflation returns to target.

Mehrdad Yousefi, industry consultant


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