RTTNews - Thursday, Bank of England deputy governor for monetary policy, Charles Bean said the bottom in economic activity may not be too far off.
In a speech in Sheffield, Bean said, Business surveys around the world do suggest that the rate of contraction in activity has been moderating over the past few months and that business confidence has started to improve.
Unfortunately these encouraging signs - I hesitate to identify them as green shoots- do not tell us much about the strength and durability of the subsequent recovery, Bean added.
He noted that the nature of the current downturn raises caution, as previous U.K. recessions were associated with the need to reduce inflation after a period of excess demand growth.
Furthermore, he said even after adopting several measures to stabilize the country's banking system, banks are yet to feel that they are sufficiently secure and can lend normally.
Past experience in other countries suggests that it often takes time for the banking system to mend after a crisis, and it is possible that the supply of credit will remain impaired for some while, Bean said.
However, a substantial depreciation in sterling and an unprecedented policy, which is working its way through, feed enough optimism about the strength of the economic recovery. But the continuing drag from the financial sector means that the ensuing pickup is likely to take place relatively slowly.
The Monetary Policy Committee has lowered Bank Rate to 0.5%, a level unmatched in the Bank's 315-year history and only marginally above its floor of zero. To contain the deep economic contraction, the BoE had announced a programme in March to buy GBP 75 billion of public and private financial assets, financed by issuing extra Bank of England reserves. In May, the central bank had increased the amount of purchases to GBP 125 billion.
Bean stressed that the primary objective of the monetary policy committee is to control inflation, not growth. The BoE expects inflation to soon fall below the bank's target of 2%. It is more likely than not to remain there for the next year or two.
When the British economy recovers, the margin of spare capacity in the economy will begin to shrink and inflationary pressures will start to build again. This will prompt the BoE to withdraw the large monetary stimulus.
Bean said the timing of the withdrawal of the monetary stimulus will be governed by the need to meet the MPC's inflation objective, not by the Government's financing needs. Further, the central bank may raise the bank rate and sell assets when it comes to tightening policy. He asserted that it is not necessary to unwind the asset purchases before raising Bank Rate.
Moreover, if there is a need to drain the extra reserves from the system rapidly, the bank could also do it by exchanging the reserves for short-term BoE bills, which will allow the central bank to stagger the sales of the gilts.
He concluded his speech saying that the rate-setting committee will face a tricky judgment while executing the exit strategy and the bank do not want to nip a recovery in the bud prematurely and to let the inflation genie out of the bottle.
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