Future Governor of the Bank of England Mervyn King is worried, about eurozone growth prospects, the impact on UK growth, and the consequent ballooning of the UK trade deficit (which hit a record 34 billion pounds last year). One small note for those who, like me, are avid detail addicts. It concerns the article's final point about UK interest rates. I think it helps to bear in mind here that Mervyn King, like his US counterpart Alan Greenspan, is pretty much on red alert over the ever-present deflation danger. The BoE must have its forecasts and expectations on likely UK inflation levels 12 to 18 months from now, and you don't have to be an economic genius to see that with the probability of cheaper oil and flat eurozone demand, deflation could become a real problem. So drop the interest rate, drop the currency and kill two birds with one stone by making imports dearer to boot. Only one snag: there are three birds out there, and dropping the interest rate won't do anything to ease the housing bubble which may, in fact, be the most serious threat facing the UK right now.
In its regular report published on Wednesday, the UK central bank predicted that growth would be running at an annual rate of about 2 per cent by the end of next year. The latest government forecast, from November, is that the economy will grow by between 3 and 3.5 per cent over the year as a whole. That forecast is expected to be revised down sharply in the UK budget, due next month. Mervyn King, the bank's deputy governor in charge of monetary policy, warned of "a weaker prospect for the world economy" than the bank had seen in November. "We have been surprised by the weakness of domestic demand in the euro area: broadly flat over the past year. It's not common for domestic demand to be flat," he said. "The weakness of domestic demand in Germany has been very marked, and has taken us a bit by surprise." The "very sharp" rise in the euro against the dollar would further weaken demand in the eurozone, he added. The enfeebled condition of the eurozone was illustrated on Wednesday by figures showing that industrial production in France fell by 1.7 per cent in December - the steepest decline for five years. On Monday, official data showed that German industrial output had suffered its sharpest drop in four years, and many economists believe German GDP is currently shrinking. Although Britain grew roughly twice as fast as the eurozone last year, by 1.6 per cent compared with 0.8 per cent, it has been suffering from a sharp fall in exports. A drop of more than 5 per cent in the last quarter of 2002 slowed growth and gave the UK a goods trade deficit worth 4 per cent of gross domestic product. Mr King said the Bank of England's revised forecast explained its decision to cut interest rates last week. The reduction of 0.25 percentage points in the bank's main interest rate to 3.75 per cent caught the markets by surprise, and fuelled speculation that the rate-setting monetary policy committee had been warned of instability in the UK financial system. The speculation was firmly rejected by Mr King.
Source: Financial Times