Bank Of England Warns Recovery Will Be Slow

LONDON (AP) -- The Bank of England warned that the recession appeared to be deeper than it previously thought and that recovery would be slow, even as it noted on Wednesday that the short-term prospects for the economy had improved.

Bank governor Mervyn King said there are signs the recent unprecedented monetary stimulus is taking effect, but stressed that the depth of the downturn meant that recovery would be protracted despite recent encouraging reports on the housing market and consumer confidence.

In a closely-watched quarterly inflation report, King added that unemployment is likely to rise for the foreseeable future and that there is a significant risk that inflation will undershoot its 2 percent target for some time.

"I'm more confident about the short-run sustainability than I was in May," King told reporters when asked about the prospect of a recovery. "But sustainablity over a longer period: there's no change. The big picture has not changed, the balance sheet adjustments that need to occur are still there and we haven't got very far down the road."

The British economy shrank by 0.8 percent in the second quarter, more than double the fall expected by economists and the fifth straight quarter of decline. The economy has now shrunk by 5.6 percent since the second quarter of last year, the biggest drop since quarterly records began in 1955.

The unemployment rate rose to 7.8 percent in the three months to June, hitting a 13-year high, according to data published Wednesday by the Office for National Statistics.

The central bank governor stressed that while the bank expects economic growth to resume over the next few quarters, as a period of robust growth after a deep recession is normal, "we will find ourselves in a difficult position for years to come."

"I don't think it's unrealistic to suppose that growth rates come back, but that doesn't mean that as far as most people and most companies are concerned, the recession will feel as if it's over," he said.

The Bank of England's quarterly inflation report was under more scrutiny than usual after the central bank surprised markets last week by opting to extend its program of buying up assets to boost the money supply.

King said he was, in turn, surprised that the decision to increase the funding injection by 50 billion pounds to 175 billion pounds had caught the market unawares, noting the bank had always been clear it would decide on the program month-by-month.

Alongside this rarely employed policy -- called quantitative easing -- the British central bank has slashed interest rates to a record low of 0.5 percent as it attempts to kick-start the economy back to life and keep inflation at its 2 percent target.

Inflation fell back to an annualised 1.8 percent in June, and the bank forecast that the inflation benchmark used by rate-setters would stay well below its 2 percent target for much of the coming two years.

King said he would probably have to write to Treasury chief Alistair Darling later this year to explain why inflation has fallen more than one percentage point below the target. He is obligated to do so under British law if inflation targets aren't met.

Economists said that raised the question of why the bank did not think it was necessary to go further with its asset purchase program, which should have the effect of spurring inflation.

"On this basis, there may be more QE to come, and a tightening of policy is certainly not on the cards for a long while yet," said Hetal Mehta, senior economic adviser to the Ernst & Young ITEM Club consultancy.

Mehta added that the bank's forecast for a swift short-term pickup in economic growth "seems highly optimistic."

"We think it is unlikely that the recovery could be so rapid given the on-going banking problems," Mehta said.

But David Kern, chief economist at the British Chambers of Commerce, said the bank had struck the right note by acknowledging the fragility of the economy and reinforcing the need for continuing with an expansionary policy stance.

King acknowledged that banks were a long way from fully repairing their balance sheets, replacing the sources of funding that disappeared in the financial crisis and emerging from state support. Britain's major banks last week reported significant first-half losses and increased provisions for bad debts.

"What we should not forget here, and those in banks particularly ought not to forget, is that the institutions that have really suffered through this recession ... have been ordinary companies that suddenly were hit by this worldwide downturn," said King. "Many of them have gone out of business and many people are losing their jobs. That recession is still there and is very deep."

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