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The British economy is entering its first recession since the early 1990s, the Bank of England's governor, Mervyn King, said last night as he delivered a clear hint that further interest rates cuts were in the pipeline.
Delivering his most significant speech for years, King became the most senior figure to admit that the economy is now contracting as a result of the credit crunch.
Describing the banking system turmoil of recent weeks as "extraordinary, almost unimaginable," he said the financial system had come closer to collapse two weeks ago than at any time in the past 90 years.
"The combination of a squeeze on real take-home pay and a decline in the availability of credit poses the risk of a sharp and prolonged slowdown in domestic demand. Indeed, it now seems likely that the UK economy is entering a recession," King told a business audience in Leeds.
"It is surely probable that the drama of the banking crisis, which is unprecedented in the lifetime of almost all of us, will damage business and consumer confidence more generally."
His fears were confirmed yesterday as the CBI reported that confidence among British manufacturers had tumbled to its lowest since July 1980, with output and orders also collapsing.
The thinktank the National Institute for Economic and Social Research says today that Britain entered a recession in the third quarter of the year and warns the slump will probably last for a year or more, making it every bit as painful as the recessions of the early 1990s or early 1980s.
Official data out on Friday will almost certainly show that the economy contracted in the July to September period, having not grown at all in the second quarter. A "technical" recession is defined as two consecutive quarters of contraction, which experts say is the least Britain can expect this time round.
NIESR says that there will be a global recession in 2009, with the worst slump in industrialised countries since 1982.
Until recently King had been more concerned about inflation, which rose to a 16-year high of 5.2% in September, driven by surging oil and food prices in the first half of the year. But with oil prices having tumbled by more than half to around $70 a barrel and with other commodity prices being sharply lower, King acknowledged inflation was much less of a concern. "During the past month, the balance of risks to inflation in the medium-term shifted decisively to the downside," he said.
That will be taken in the City as a strong hint that the Bank's monetary policy committee will cut rates again next month following the emergency half-point rate cut it made together with other central banks around the world on October 8.
Rates are currently 4.5% in Britain but many economists expect rates to be cut next year to as low as 2.5% as the MPC seeks to prevent the recession being deep and prolonged.
NIESR goes further, calling for further big rate cuts in Britain and the United States, recommending the Bank of England cut to 2% and the Federal Reserve to zero from the current 1.5% level.
King warned that a meltdown in the global banking system had only just been avoided earlier this month when the share prices of HBOS and RBS collapsed, forcing the government to launch its partial nationalisation of the sector. "Following the failure of Lehman Brothers on September 15, an extraordinary, almost unimaginable sequence of events began which culminated a week or so ago in the announcements around the world of a recapitalisation of the banking system.
"It is difficult to exaggerate the severity and importance of those events. Not since the beginning of the first world war has our banking system been so close to collapse," he said.
He stressed that the actions taken by the British government and others around the world to recapitalise their banks "were not designed to save the banks as such, but to protect the rest of the economy from the banks".
He sounded an optimistic note that the worst may be past for the banking system. "With the bank recapitalisation plan in place, we now face a long, slow haul to restore lending to the real economy, and hence growth of our economy, to more normal conditions."
- Recession
- Bank of England
- Banking sector
- Interest rates
- Interest rates
- Credit crunch
- Market turmoil
- Economics
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