The Governor of the Bank of England commented on the economic outlook to the Treasury Committee on Tuesday 25 November 2008.
Synopsis:
The current economic environment has led to a situation where inflation is falling sharply and there is less economic activity.
Three key factors are identified as drivers to the current situation:
- The Failure of Lehman Brothers – this has badly affected confidence in the financial markets and the flow of lending to households and business has been severely disrupted.
- The Short-Run Indicators for Activity – these have down turned down sharply in the UK and overseas. There has been a fall in demand in the economy and the UK probably entered a recession in the second half of 2008. Unemployment has been rising at its fastest rate for seventeen years.
- CPI Inflation fell to 4.5% in October – oil prices have collapsed & world metal prices have halved. The cut in VAT announced this week will also lower inflation in the short run.
The combination of these factors has shifted the outlook for inflation down significantly. It is likely that inflation will fall to target at some point early next year, the speed of this will depend on how quickly the depreciation of sterling feeds into consumer prices.
The Monetary Policy Committee is attempting to balance the potential fall in inflation with a corresponding decrease in interest rates. This has been complemented by significant policy measures taken by the Government. Two actions are being instituted to mitigate the slowdown in activity in the next year:
- Recapitalisation of the banking system aimed at increasing confidence.
- Increase consumer confidence & spending in the short-term.
The major challenges ahead are:
- Ensure that in the UK normal bank lending is resumed.
- Internationally, reforms of the international monetary system and improvements to the regulation of banks’ capital and liquidity provisioning are priorities.
The Monetary Policy Committee is focused on taking whatever action is necessary to ensure that inflation is close to target in the medium term in order to help the economy resume growth at a sustainable rate.
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