Mervyn King used his speech at the annual Mansion House dinner to reassure people that recent inflation spikes would not panic the central bank into increasing rates too soon, whilst also welcoming the announcement by chancellor George Osborne that the Bank would regain control of banking regulation.
“Our ability to keep measured inflation close to the target has been hindered by movements in world oil and commodity prices, as well as the temporary reduction in VAT,” King said. “A continuous rise in prices would ordinarily be associated with strong money growth, wage inflation, rapid increases in money spending and an excess of demand over the supply capacity of the economy – the UK economy exhibits none of these traits.”
A range of indicators pointed to spare capacity in the economy, which the Monetary Policy Committee believed would “press down on inflation” – as seemed to be happening in the US and also in the eurozone.
The MPC “will not hesitate to begin to withdraw the current degree of stimulus when we judge that is necessary,” King went on.
“When it comes, that is most likely to be through a rise in Bank Rate with asset sales being conducted later....but monetary policy must be set in the light of the fiscal tightening over the coming years, the continuing fragility in financial markets and the state of the banking system.”
The governor told the Chancellor, sitting beside him: “I know there are those who worry that too rapid a fiscal consolidation will endanger recovery. But the steady reduction in the very large structural deficit over a period of a parliament cannot credibly be postponed indefinitely.
“If prospects for growth were to weaken, the outlook for inflation would probably be lower and monetary policy could then respond,” he added.
King said the crisis had shown that switching banking regulation to the Financial Services Authority “didn’t work”, and he was “delighted” with the decision of FSA chief executive Hector Sants to accept Osborne’s invitation to become the first chief executive of the new prudential regulator, and deputy bank governor.
“In a crisis, the central bank, working with government, needs to be in charge,” King said. “I welcome those new responsibilities. Monetary stability and financial stability are two sides of the same coin. During the crisis the former was threatened by the failure to secure the latter.”A Financial Policy Committee would judge the required level of capital buffers over the economic cycle and “could help forestall both excessive exuberance and unnecessary caution”. King said, adding: “This type of regulatory regime, and its objectives and tools, are largely untried and untested. But that is not a reason for not trying and not testing”.
Osborne, who had confirmed the regulatory shake-up in the Commons earlier, said: “The Bank of England was mandated to focus on consumer price inflation to the exclusion of other things. The Treasury saw its financial policy division drift into a backwater. The FSA became a narrow regulator, almost entirely focused on rules-based regulation. No-one was controlling levels of debt, and when the crunch came no-one knew who was in charge.”
He commended Alistair Darling for his “integrity and good intentions” but told City financiers: “The legacy of the crisis is a cloud of uncertainty hanging over your industry. I believe that has to be dispelled if we are to achieve our broader goals for the economy.”