King comments on economic downturn

There is little doubt that like other nations and economies the UK in is the throes of what promises to be a long and painful recession, and with the country still reeling from the many adverse effects of the global credit crunch the outlook isn’t too bright. This is made worse still by reports that the International Monetary Fund has recently predicted that Britain will be amongst the hardest hit of the major economies as a result of the financial crisis and the recession, painting a very bleak picture for the course of this year.

Recently, the Governor of the Bank of England, Mervyn King, made a long and poignant speech about the state of the economy at the CBI dinner in Nottingham. His speech addressed various aspects and issues relating to the financial crises, the recession, and the changes that have taken place both nationally and globally over the past year.

Mr King began: “Certain truths are self-evident. One is that financial markets and the economic outlook can change quickly and in surprising ways. You in the Nottingham business community know that only too well. In line with businesses across the United Kingdom, your economic fortunes have changed markedly over four months. Before last September, the world economy was slowing and at home the Monetary Policy Committee published a central projection of falling output in the United Kingdom in the third quarter. Inflation, though, was still rising. But after the failure of the American investment bank Lehman Brothers, there was a widespread collapse of confidence in the banking systems of the industrialised world. That led to an unprecedented and synchronised downturn in business and consumer confidence around the world. Our business contacts at home and abroad, and my international counterparts, started to report that orders and confidence had, in the same telling phrase, “fallen off a cliff”.”

King went on to outline some of the problems that had been experienced not just in Britain but on a global basis and affecting many different major economies. He continued: “Global equity prices fell more in the month following the failure of Lehman Brothers than in any but a handful of months in the Bank of England’s 300 year history. Chinese electricity production, having risen steadily at 15% a year, fell in November to a level 8% lower than a year earlier – the steepest fall on record. Car sales in Brazil contracted by a quarter compared to a year earlier. In Japan, industrial production fell by 8.5% in just one month in November, and in Germany, the value of exports declined by over 10%. In the United States, over a million jobs were lost in the final two months of last year – the fastest rate of job losses in over 60 years. And in the United Kingdom, manufacturing output contracted at its fastest rate since 1980. Trade was badly affected – the Baltic Dry Index, an indicator of demand to ship materials around the world – fell at the fastest pace on record in October. For the world economy as a whole, consensus forecasts of growth in 2009 have been revised down from 3% to just 1% since September.”

He told attendees at the CBI dinner that both central banks and government around the world had tried to act positively to try and combat these issues, stating: “Governments and central banks around the world responded decisively and boldly with large fiscal injections and cuts in interest rates, and the provision of hundreds of billions of pounds in capital and funding to support banks. The scale and urgency of their actions embodied an audacity born out of pessimism.”

Amongst other issues, he also addressed the problems that have hit the banking industry over the past year, and he said: “In the past year the true scale of the risks taken by financial institutions has become painfully apparent. As losses mount it has become obvious that banks did not have sufficient capital to support their inflated balance sheets. Questions about the adequacy of liquidity have turned into questions about solvency. In response, banks have been trying to raise new capital and shrink their balance sheets. The banking system is in the throes of a difficult and prolonged adjustment to much smaller balance sheets relative to their equity capital – or leverage, as it is known. Leverage ratios of large banks remain at remarkably high levels, and the required adjustment will not happen quickly.”

He added: “I know that bankers around the world realise this. The incentives they face to adjust, in whatever way they can, are now overwhelming. With fresh capital from the private sector difficult to obtain, banks have opted to reduce their lending and that is why the flow of credit to all parts of the economy, here and abroad, has been heavily disrupted.”

In conclusion Mr King ended his speech stating: “…the very significant policy actions taken in recent months will eventually stimulate a recovery in demand, output and employment. Bank Rate has fallen from 5% to 1½%. And, as I have explained, the Monetary Policy Committee has a range of options to stimulate the economy further if required. Fiscal policy has been eased. The banking system is receiving massive support to cope with the need to restructure its balance sheet. That will take time, but time is a great healer, even of banks. Since the summer, the exchange rate has fallen by almost 20%; and oil prices have fallen by around two thirds, both of which will boost demand. No one can know at what point the impact of all this stimulus will have a visible effect on activity; the lags in economic policy are notoriously long and unpredictable. But well-designed policies implemented within a consistent policy framework will eventually work.”