The recovery is “in sight”, Sir Mervyn King has declared, as he gave a final, upbeat assessment of the state of the economy before retiring from the Bank of England.
The outgoing Governor gave the UK a rare vote of confidence as the Bank raised its growth forecasts and lowered its inflation outlook for the first time since the recession struck five years ago.
Sir Mervyn also threw his weight behind the Chancellor just days before a delegation from the International Monetary Fund (IMF) passes judgment on George Osborne’s economic strategy. The Governor attacked IMF “quibbling” over the Government’s austerity programme, saying current policy was “highly appropriate”.
In a separate speech on Wednesday night, the Chancellor threw down the gauntlet to his critics at the IMF by pledging not to change course. “We will stick with our approach,” he told the CBI’s annual dinner, adding: "Now is not the time to lose our nerve."
In its quarterly Inflation Report, Sir Mervyn’s last after a decade as governor, the Bank forecast economic growth this year of 1pc, up from its 0.9pc projection in February, and for inflation to peak at 3.1pc in June, a little lower than its previous outlook. The pick-up will be immediate, with growth of 0.5pc in the three months to June following the 0.3pc expansion in the first quarter.
“Today’s projections are for growth to be a little stronger and inflation a little weaker than we expected three months ago. That is the first time I have been able to say that since before the financial crisis,” Sir Mervyn said. “A recovery is in sight.”
He cautioned that the economy “is likely to remain weak by historical standards” due to excessive private and public sector debt, low household income, and hesitant business investment. But the Bank insisted “a modest and sustained recovery over the next three years” was underway. A new flare-up of the eurozone crisis remained the biggest risk, the Bank added.
The Chancellor welcomed the positive sentiment and dropped a hint that he believes the economy has turned the corner. “The fact is, the most recent economic news has been more encouraging. The economy is growing. Surveys are better. Confidence is returning to financial markets,” he said.
The relatively upbeat mood was in stark contrast to the comments made by senior figures at the IMF last month. They suggested the UK should slow the pace of austerity to boost growth or risk losing control of the public finances. The IMF’s UK review team is due to deliver its final report next week.
But, in his swansong performance, the Governor threw his support behind the Chancellor, saying Britain “would be well into a recovery” had global growth been around trend and that the IMF was wrong.
“Almost everyone believes that countries need medium term plans for fiscal consolidation and for the automatic stabilisers to be allowed to work. That’s what we’ve got and why the deficit hasn’t come down anywhere near as much had been hoped. That seems to me highly appropriate,” he said.
“The scale of this is much bigger than any of the quibbling in the margins that seems to come out in much of the debate.”
The Chancellor later said: “Just as the argument for fiscal stimulus three years ago was mistaken, so is the suggestion for a discretionary fiscal loosening now. Are those advocating looser fiscal policy really suggesting we should set out to increase our deficit year on year when it is still larger than when Britain went to the IMF in 1976?”
Sir Mervyn also backed the Chancellor’s controversial Help-to-Buy temporary mortgage guarantee scheme, which some consider to be a sub-prime crisis in the making.
“In present circumstances, something to increase the level of [housing] transactions is helpful,” Sir Mervyn said. “What we don’t want is a system of permanent guarantees for mortgages. That would be a very dangerous path.”
He welcomed the Chancellor’s decision to introduction of greater flexibility in the Bank’s 2pc inflation target, but he said it “would not have affected” the Bank’s response to the crisis. The Chancellor has asked the Bank to report back in August on how it might use new “guidance” powers under the incoming Governor Mark Carney. Sir Mervyn revealed the Bank’s Monetary Policy Committee is already in discussions with Mr Carney.
However, the Governor warned: “There are clearly limits to what monetary policy can hope to achieve in the present situation in any form. I don’t think there is a magic bullet here that can be used to expand demand.”
Revisiting his attack on Labour’s handling of the bank bail-out in 2008, he said the UK “would have been in a better position” now had the authorities taken his advice at the time and recapitalised the lenders more fully.
The Bank’s Inflation Report projections also showed that markets believe rates will remain at 0.5pc until late 2016 at the earliest – more than a year later than expected just three months ago – and below 1pc into 2017.
Providing a new degree of transparency at the Bank, it also revealed that it expects unemployment to fall “by only little” from the current level of 7.8pc in the coming year.