'Painful' years ahead for economic recovery
Updated on 12 May 2010
Bank of England Governor Mervyn King's prediction today that the financial crisis is "far from over" is a warning of the daunting fiscal challenge facing the new coalition, writes Faisal Islam.
Mervyn King welcomed the forging of a stable government and said that markets have been "waiting for the election to be over". Now markets "need and want a very string signal" from the new administration, he said.
The governor of the Bank of England warned today that the financial crisis was "far from over" despite clear signs of economic recovery.
His comments came as the bank's quarterly inflation report predicted a pick-up in growth - though it added that conditions remain uncertain. It warned that pace of recovery will be dampened by the need for "substantial fiscal tightening", but anticipated a further strengthening of banks' balance sheets.
Analysis from econonics editor Faisal Islam:
Coruscating words from the Governor of the Bank of England Mervyn King about the immediate need for spending cuts in this financial year, in the coming months.
The Chancellor of the Exchequer George Osborne spoke this morning to Mr King to talk him through the joint policy Agreement of the new government. There are some important developments.
First and foremost, Mr King has backed the Conservative plan for £6 billion of cuts in the coming months. This provides some political cover for Vince Cable and Nick Clegg's harsh statements against this policy in the election campaign.
Mr King has also shifted his position a little, but he says this is a direct result of the turmoil in European government debt markets over the past two weeks. Mervyn King thinks the risks have changed fundamentally given this turmoil and we have a brief window of opportunity to hammer home the UK's fiscal credibility to the markets.
Some of the statements made by Mervyn King were his harshest yet and presage 'a few painful years' as we are only 'half way through the financial crisis'. King believes that what was unleashed on sovereign debt markets last week had the potential to be a 'much worse' crisis than we had in 2008.
He added that the pick-up is forecast to accelerate in the coming months: "The recovery is likely to gather pace over the next year, underpinned by the considerable stimulus stemming from the highly accommodative monetary stance, together with a projected further expansion of world demand and past depreciation of sterling."
But this pace will be dampened by fiscal consolidation and the need for a more robust banking sector.
Dealing with the deficit
The governor said today that dealing with Britain's record debt would be "painful" for a few years to come. Mr King expressed confidence that the coalition would be able to come up with a clear plan to tackle the issue. The first role of David Cameron's coalition, he said, was to convince the markets that deficit plans would actually take effect.
"The most important thing now is for the new government to deal with the challenges of the fiscal deficit," Mr King said.
"It is the single most pressing problem facing the UK and it will take a full parliament to deal with it.
"I have been told what is in the agreement between the Conservatives and Liberal Democrats this morning and I am very pleased that there is a very clear binding commitment to accelerate the reduction in the deficit."
The governor added that the coalition agreement set out "includes an accelerated programme to reduce the fiscal deficit over the lifetime of this parliament and introduces £6bn of cuts this financial year".
"It's not going to be easy," Mr King said.
"It's going to be a painful few years in dealing with these adjustments but we have faced the biggest financial crisis that the world has seen.
"It has caused problems for the public sector in every country in the world but it has caused problems here - we have a very large fiscal deficit and we have to demonstrate that we are capable, as I'm quite convinced we are, of dealing with this problem."
However David Blanchflower, a former member of the Monetary Policy Committee told Channel 4 News that the new government's planned £6bn cuts would damage the economic recovery.
"Anybody who is going to start cutting in that position is basically going to push us in that death spiral. That's what we've avoided until this date.
"We need to stimulating growth, not withdrawing multiple billions out of the system," he said.
