MercoPress. South Atlantic News Agency

Recession for “some time” to come predicts Bank of England

Mervyn King said BoE considering cutting interest rates for deposits held by banks

Households and businesses will be hit by the recession for “some time” despite recent signs of growth, Bank of England Governor Mervyn King has warned. Mr King said the impact of dampened demand and soaring unemployment would linger long after the ailing UK economy began its slow recovery from the worst slump in almost 30 years.

Despite a likely return to growth in the third quarter of 2009, the Governor warned: “Growth rates don't tell the full story, it's the levels that matter.”

He added: “For most businesses and households the recession will continue for some time.” Figures due on Wednesday are set to show UK dole queues rising to almost 2.5 million and they are likely to top the three million mark next year.

Banks also face further hefty bad debts as the effects of unemployment and the slump see individuals and businesses struggle with repayments long after a recovery begins, Mr King warned. This will mean they need to build up a buffer against future losses, cutting dividends and constraining pay and bonuses, he said. The effects of the crisis sparked by the collapse of investment banking giant Lehman Brothers a year ago would be “pervasive and long-lasting”, the Governor added.

The Bank's rate-setters have slashed interest rates to a record low and are pumping £175 billion into the money supply through quantitative easing to ward off Japan-style deflation. But concerns are already growing that the pressure for banks to hold on to cash to bolster their balance sheets is leading them to hoard the extra money being pumped in rather than pass it on to borrowers.

Mr King confirmed the Bank is considering cutting the interest rate for deposits held by banks to dissuade them from storing up cash. He said a lower deposit rate “could make the banks work a little bit harder” to convert their reserves into other assets.

King also forecast a volatile path ahead for inflation, although the Bank's Consumer Prices Index benchmark fell by less than expected to 1.6% in August.

Inflation is set to fall further below the Government's 2% target before rising above this level in the months ahead due to factors such as the reversal of stimulus moves like the VAT cut. The risk remains for below-target inflation in the medium term, according to Mr King.

Figures showed CPI at its lowest level in almost five years as unchanged household energy bills this year compared with big hikes 12 months earlier dragged down the rate of inflation, along with falling food prices. The smaller-than-expected fall in the CPI was due to soaring petrol prices, with the average litre of petrol rising 1.1p to 103.8p over the month compared with a 5.5p fall 12 months earlier.