BoE King Warns of Slowing Growth

Two interest rate cuts will be needed next year to stem an economic slowdown, the Bank of England indicated yesterday in its most gloomy inflation report for years.

Mervyn King, the Bank governor, said the global credit squeeze would hit UK growth hard early next year, with risks of a further fallout from falling share prices and currency tensions in the world economy.

Money market investors and economists interpreted his comments as a clear signal that rates would soon come down. Mr King said decisions on rates would be difficult in the coming months and the important question was whether "the slowing we expect to see, or we're going to see, [is] bigger than the slowing that we have wanted to see".

The Bank's forecasts showed inflation falling well below its 2 per cent target in two years if UK interest rates were held at 5.75 per cent but on target if the Bank cut rates twice in 2008. Mr King said the forecast slowdown was "certainly sharp compared with a very small movement that we have seen over the last 10 years".

The pessimistic outlook for growth at the start of 2008 results from the Bank's judgment that credit conditions will tighten for companies and households. More expensive borrowing would hit corporate investment, the property market and construction, while also encouraging households to shift from borrowing to saving.

Mr King also made it clear that he thought equity markets had not adequately priced risk yet and warned that a significant risk to the world economy lay in the threat of falling equity prices. He said the tensions in global currency markets would continue as the huge trade imbalances began to unwind.

"I came away from the IMF meetings in Washington recently more concerned about the implications of these tensions precisely because the unwinding of the imbalances is not just a hypothetical prospect out there, but is happening now and I think this is a major concern," he said.

Economists were united in their expectation of rate cuts after listening to the governor. Malcolm Barr, of JP Morgan, said the MPC had opened the door to lower rates before February by "signalling a willingness to act reasonably swiftly to limit downside risks to growth".

Alan Clarke, of BNP Paribas, said the report was so pessimistic on growth he now believed the MPC would cut rates in December, especially if mortgage approval figures and service sector surveys continued to be weak.

Asked whether the retail run on Northern Rock was something that had made him consider resignation, Mr King said: "No." He again refused to be drawn on whether he sought another term as governor, now saying that it was a matter for the new year.

The US Federal Reserve, meanwhile, unveiled a shake-up of its communications strategy, adopting many of the features of an inflation-targeting approach to monetary policy without actually stating such a target. The Fed will start publishing more frequent, more detailed and longer-range economic forecasts including, for the first time, forecasts for inflation including food and energy.