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Friday, 31 October 2008

Bank of England under fire over handling of downturn

The Bank of England failed to respond to warning signs of a looming recession and had been wrong to delay cutting interest rates until too late to stop growth contracting and unemployment rising sharply, a member of the Bank's monetary policy committee (MPC) said last night.
Speaking as the US Federal Reserve cut interest rates to just 1% in an attempt to halt a slump in activity, David Blanchflower launched an outspoken attack on his eight MPC colleagues, saying the Bank had been too optimistic about the UK's ability to survive the global crisis, and Britain would now endure 18 months of falling output as it felt the full impact.
The Bank is expected to follow the Fed's lead by cutting at least half a percentage point off UK rates next week, although some analysts want a one point cut after news the economy shrank by 0.5% in the third quarter of this year.
Blanchflower's intervention came as David Cameron attempted to pile the pressure on Gordon Brown when the Tory leader challenged the prime minister to admit that his fiscal rules were now dead and he was planning a "spending splurge".In their most bruising encounter in the crisis, Brown hit back at prime minister's questions by accusing the Tories of mixed messages, saying in one breath that it was right to increase borrowing in a recession and saying in another that it was not.
Cameron asked of the fiscal rules: "Why will he not now admit that they are dead? Let us just remember them - he used to be so proud of them. Rule one was: 'Only borrow to invest'; now he is having to borrow to pay for unemployment benefit. That rule is dead. Rule two was: 'Don't have debt over 40% of national income.' Even on his own fiddled figures, that rule is now dead. Why will he not admit that the rules failed to deliver responsibility in the good years and that, as soon as the bad times came, they collapsed completely?"
In a speech last night, chancellor Alistair Darling said it would be "perverse" to stick rigidly to the rules during a downturn.
Blanchflower was a lone voice on the MPC calling for cuts in interest rates this summer. Speaking in Canterbury last night he criticised fellow MPC members for ignoring his warnings. "I believe the trend has been apparent for some time. The synchronised downturn in so many surveys should have led us to realise sooner that the UK economy was entering a recession," he said.
"If rates are not cut aggressively [when the MPC meets next week] we do face the prospect of a relatively deep and long-lasting recession."
In his speech, he said tighter credit conditions imposed by banks had yet to be fully felt. Policymakers faced an "unusually severe" international financial problem, possibly more significant than 1929, a crash which principally involved bank failures in the US. "The current difficulties in financial markets are more comparable to what happened in world war one, when stock exchanges in several countries closed for extended periods."
The MPC had been reluctant to cut rates during the summer as inflation rose to a 16-year-high of 5.2% in September.
Blanchflower said the MPC had over-reacted to the threat of higher imported oil and food prices repeating the 1970s inflationary spiral. But workers' bargaining power was weaker now, with little chance that they could push up wages in response to rising prices.
"In its last health check on the economy, released in August, the Bank said it expected output to be flat over the coming year, with employment falling a little. Output growth was expected to recover in 2009 as energy prices fell, the credit crunch eased and a weaker pound helped exports. This was an optimistic view," Blanchflower said. "Clearly output is now beginning to contract, but I think this likelihood was apparent in August."
He added that at last month's MPC meeting some had argued for higher borrowing costs. "I was alone in voting for an immediate cut of half a percentage point. I am concerned about the detrimental effect of recent events in financial markets on the UK economy," he said, adding that the 0.5% drop in GDP had occurred mainly before this autumn's market meltdown.

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