More shocks to come for economy

27 February 2008

The global economy is currently in the midst of the worst financial and banking crisis ever seen in peacetime and there are even more shocks to come.

That was the stark warning from the Bank of England’s deputy governor Rachel Lomax in a speech yesterday (26 February).

Lomax, who is also a member of the Monetary Policy Committee (MPC) responsible for setting interest rates, painted a bleak picture during her speech noting that financial stress will act as a drag on demand for the next two years, and that the financial crisis will persist and even intensify.

She said: “There have been financial banking crises before but not on the present global scale and this must surely be the largest ever peacetime liquidity crisis.”

The latest figures show that Britain’s economy grew at a slower rate in the final three months of 2007 with consumer spending also growing at a lower rate.

Gross Domestic Product (GDP) growth slowed to 0.6% in the final quarter, leaving the annual rate at 2.9%. And the growth of consumer spending slowed sharply to a rate of 0.2% from 0.9% in the third quarter.

As well as predicting a sharp rise in inflation in the near time, Lomax forecast that credit markets causing the current disruption are likely to remain illiquid – which is bad news for banks and other financial institutions struggling to raise funds for lending activity. It also means mortgage rates are unlikley to fall in the short-term.

As well higher mortgage repayments, the rising cost of gas and electricity, water and food are putting additional pressure on most household budgets. But Lomax believes that the rising wholesale costs of oil and the decline of sterling has not yet fed into consumer prices - meaning people's finances could be stretched even further.

Interest rate cuts unlikely

If inflation does rise sharply in the near future, then an interest rate cut by the MPC over the next few months looks increasingly unlikely. In fact, if inflation starts to move upwards at a rate that suggests it could breach the 3% mark – the point at which the Bank of England’s governor Mervyn King must write to the chancellor with an explanation – then interest rate increases could be on the cards.

But Lomax said that the pick-up in inflation is likely to be short-lived. She added that the MPC won’t have to raise interest rates to counteract the rise in inflation so long as price and wage setters do not assume that higher inflation is a long-term trend.

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