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King defends UK economic policy

26/01/2011 14:44
The Bank of England has robustly defended the UK government’s economic strategy, urging it to stick to tough public spending cuts in spite of shock figures showing the inflation-prone economy shrunk at the end of last year.

Mervyn King, the bank governor, said the economy’s 0.5 per cent contraction in the fourth quarter proved the recovery would be “choppy”. But he used the economic weakness to defend the central bank’s ultra-loose monetary policy in the face of high inflation.

Mr King said the British economy was “well placed for a return to sustained, balanced growth”.

He told a Newcastle audience there would be ups and downs but added: “The right course has been set and it is important to maintain it.”

But Mr King said households would have to accept a period of austerity because of the need to raise consumption taxes and cut spending to bring the deficit under control.

The central bank neither could, nor should, try to prevent that squeeze in living standards, “half of which is coming in the form of higher prices and half in earnings rising at a lower rate than normal”, he said.

The governor predicted inflation would soon rise to between 4 per cent and 5 per cent, more than double the bank’s 2 per cent target.

Markets reacted with concern. Sterling fell to a two-and-a-half month low against the dollar, dropping 1.5 per cent to stand at $1.58.

Gilt yields fell sharply at short maturities as investors reassessed expectations of interest rate rises.

George Osborne, the chancellor, and the governor are united in their belief that Britain’s structural deficit should be eliminated within four years, but they now face a tough adversary in the abrasive Ed Balls, the new shadow chancellor, who argues that the ­priority should be growth. The economic debate at Westminster has been transformed in a matter of days. This week Sir Richard Lambert, outgoing chief of the CBI, the employers’ group, ­bolstered Mr Balls’ case by criticising the coalition’s growth strategy.

“My advice to George Osborne is don’t blame the weather: change your mind, get a Plan B, get a policy for jobs and growth and do it quickly,” Mr Balls said, claiming that the economy was too fragile to withstand cuts.

But the chancellor insisted he would not be “blown off course”, pointing out that the Office for National Statistics had said that December snow had lopped 0.5 per cent off growth in its preliminary figures, which would otherwise have been flat.

“There is no question of changing a fiscal plan that has established international credibility on the back of one very cold month,” Mr Osborne said.

Most economists discounted the effect of snow, but warned that the underlying figures showed weakness in the economy as fiscal tightening began.

In spite of rising inflation, Mr King refuted any suggestion that the Bank might have gone too far in lowering interest rates to 0.5 per cent and pumping £200bn into the economy.