‘Long and winding’ UK recovery, warns Mervyn King

Those two problems – flat output and rising inflation – are feeding on each other, writes Channel 4 News Business Producer Neil MacDonald.

Because inflation continues to outstrip take home pay, real incomes are being squeezed. So consumer spending – the largest part of economic activity – is continuously under pressure. The bank’s forecast today that inflation will stay above the official target of 2 per cent for much of next year will hobble the already weak recovery.

Less than a month ago, there was optimism generated by the latest growth figures, which showed the economy expanded by 1 per cent in the third quarter of the year. But the governor said that good news was not a reliable guide to our future prospects as it was flattered by the impact of the Olympics.

The bank’s traditional response to an inflation problem would be to raise interest rates – but the governor rejected this, pointing out that higher interest rates over recent months would simply have meant a deeper recession.

The Bank of England is particularly concerned that much of the recent rise in inflation is coming from areas which it can’t do much about.

The bank is particularly concerned that much of the recent rise in inflation is coming from areas which it can’t do much about, with the governor pointing the finger at the increase in tuition fees and the surge in energy bills.

On top of that, the world economy remains an unfriendly place for the UK as it tries to rebalance its economy – away from debt-fuelled consumption and towards manufacturing and exports. Sir Mervyn was particularly gloomy here – saying that he saw “little sign of any change” to the crisis in the eurozone.

British exports have been helped by the fall in the value of sterling over the last few years. But even that escape route could be closing, with the governor pointing out that the pound has now risen in value against the euro by 12 per cent, making British exports more expensive in our largest export market.

There was one crumb of comfort: Sir Mervyn thinks there’s no reason why the British economy shouldn’t eventually return to its long run average rate of economic growth. But he suggested that would only happen in the very long run – possibly decades.