Is lack of credit stifling economic recovery?

The Bank of England’s inflation report was released today, in which Governor Mervyn King said the UK economy had ‘only just started’ along the road to recovery.

Mr. King states:

“The UK economy is facing a prolonged period of balance sheet adjustment. That will not be achieved in a few quarters. The banking system is reducing its leverage from extraordinarily high levels. Until that has taken place the supply of credit to households and businesses will be impeded. Those same households and businesses are re-evaluating their own financial positions – looking to build up their savings in the face of uncertain incomes and profits. That, when combined with impaired access to credit, will continue to restrain spending. And the need for a credible plan to ensure a substantial reduction in the fiscal deficit is now clear to everyone. This process of balance sheet adjustment implies the need for the UK economy to rebalance away from private and public consumption towards higher net exports. The fall in the exchange rate over the past two years will help to smooth that process.”

He continues:

“When we met last November, the full ramifications of the financial crisis were just starting to become clear. The banking system was in near meltdown. Output, orders and confidence had “fallen off a cliff”, to use the phrase that we heard so often from around the world. We have come a long way since then, helped in part by the extraordinary policy actions that have been implemented. We have, however, only just started along the road to recovery and the adjustment to balance sheets still has much further to run. Monetary policy cannot – and should not seek to – prevent that adjustment. But by acting to keep inflation on track to meet the 2% target, monetary policy can facilitate a smoother path of adjustment towards the rebalancing of the UK economy.”

But commenting on the report, Liberal Democrat Shadow Chancellor, Vince Cable said:

“It’s very clear from this gloomy analysis that the heart attack suffered by the British economy has had profound long-term effects. There can be no question of a return to business as usual.

“Those in the City who are getting excited about temporary improvements in the stock market, housing market and bank profits should realise that we need deep and major changes in order to rebalance the British economy in a fundamental way. This means not just a clear plan for working down the structural deficit but a commitment to rebuilding British infrastructure, making the economy less dependant on the banking system and breaking up the big banks so that they are not putting the economy at risk in the future.

“What is very striking is the Governor’s reference to a continued famine of credit to good British companies. Since the taxpayer has rescued the banks, they cannot be allowed to continue suffocating British industry and business generally. The Government must be much more proactive in ensuring that the banks, particularly the nationalised and semi-nationalised banks, lend to corporate customers.”