King Says BOE Braced for Euro Debt Crisis Risks: Economy

Bank of England Governor Mervyn King said officials have prepared for dangers posed by Europe’s debt crisis, after the bank lowered growth forecasts and raised predictions for inflation this year.

“Contingency plans have been discussed and have been for a considerable time,” King said at a press conference to present the bank’s quarterly Inflation Report today in London. “We are navigating through turbulent waters with the risk of a storm heading our way from the continent.”
Greece is heading for new elections after a political stalemate that’s sent stocks across Europe lower, pushed up bond yields and raised concern the nation may leave the euro region. King said the currency bloc is facing a prolonged period of “sluggish” growth that will affect the U.K. and that the Bank of England has the option to respond if needed.

Policy makers voted to halt expansion of stimulus last week after some officials stepped up their rhetoric on inflation, which has been above their goal for more than two years. King said today that there’s a case both to expand bond purchases or to hold fewer securities and that the risks to inflation in two years are “broadly, evenly balanced.”

“The asset purchases we made between October and last month will continue to stimulate the economy for some time to come,” King said. “The fact we’ve not continued the program at this stage doesn’t mean to say the effect doesn’t continue to pass through the economy — it does — and the option is still open to us also.”
New Forecasts

Inflation will be about 1.6 percent in two years after staying above the 2 percent target for longer than it predicted in February, the central bank’s forecasts show. Officials also said that U.K. growth is likely to remain “subdued” in the near term, held back by the government’s fiscal squeeze, the pace of the global economy and tight credit conditions.

Gross-domestic-product growth is seen at about an annual 2.6 percent in two years, according to the forecasts. The bank publishes its quarterly predictions in the form of fan charts without specifying exact numbers. It will release data indicating exact figures next week.

“The economy will recover much more slowly than the BOE predicts,” said Peter Dixon, an economist at Commerzbank AG in London. “By underestimating both the extent of deleveraging and the slowdown in potential growth, the BOE continues to run the risk of overstating the economy’s capacity to rebound.”
Financial Crisis

Ten-year gilts rose after the release of the inflation report, pushing the yield to a record low of 1.821 percent. The yield was at 1.855 percent as of 12:15 p.m. in London. The pound fell 0.4 percent to $1.5924.

European stocks retreated, sending the Stoxx Europe 600 Index to the lowest level this year, amid deepening speculation on Greece’s future in the euro currency bloc. Swedish Riksbank Deputy Governor Per Jansson said in a May 11 interview that central bankers across Europe have started discussing the possibility of a Greek exit and how to handle the fallout.

The Bank of England held its key interest rate at a record low of 0.5 percent on May 10 and kept its bond-purchase target at 325 billion pounds ($517 billion). Officials said today that despite the changes in the near-term outlook, “the fundamental policy challenges” after the financial crisis and recession have stayed the same.

“There are major problems ahead,” King said. “There are major credit losses to be realized. Whatever happens there will be difficulties ahead that will undoubtedly affect us” and “it is not sensible to think solely in terms of ‘euro stays together — excellent. Euro comes apart — disaster,’” he said.

“I don’t think anyone is under any illusion that we’re not all going to be affected by this,” King said. “Our banking system is exposed to the euro area. We certainly are going to be affected.”
Growth Outlook

In the Inflation Report, the central bank said concerns about the “possibility of a disorderly resolution” in the euro area have “adversely influenced asset prices, bank funding costs and confidence. Even if a disorderly outcome is avoided, the possibility of such ‘‘extreme outcomes crystallizing will continue to weigh on U.K. activity.’’

Britain’s economy shrank 0.2 percent in the first quarter after a 0.3 percent contraction in the previous three months. Bank of England chief economist Spencer Dale said surveys and other reports suggest underlying growth is stronger and the official GDP data may be revised up.
Inflation Concerns

While the euro threats are mounting, so too are inflation concerns, with consumer price growth accelerating to an annual 3.5 percent in March from 3.4 percent the previous month.

Deputy Governor Paul Tucker said April 18 that the ‘‘uncomfortably above target’’ rate could hold above 3 percent into the second half of the year. Minutes of the May 9-10 policy meeting will be published on May 23.

Separately today, euro-area inflation slowed to 2.6 percent in April from 2.7 percent in March, the European Union’s statistics office said. That’s in line with an initial estimate published on April 30.

Australian consumer confidence hovered near the weakest level this year and wage growth slowed, underpinning bets the central bank will cut interest rates next month to the lowest level in more than two years. In the U.S., housing starts likely rebounded from a five-month low in April, economists surveyed by Bloomberg News predicted. Building permits probably fell in the same period, another survey showed.