The Great Debate UK

from Breakingviews:

Inflation’s gonna be OK, says Merv

Mervyn King, Governor of the Bank of England, sees a long, hard road back to the path we thought we were on before the financial crisis broke. Just how long is shown by  Chart 2 in Wednesday's Quarterly Inflation Report. The Bank's Monetary Policy Committee does not expect Britain's GDP to return to its peak, 2007, level until 2011, and there's an outside chance that even in 2012, the country's output will be no more than it was in 2006.

This "considerable period" of "sustained weakness of demand" is why the MPC's other fan chart, the "rivers of blood" projections of inflation, looks so benign. The best guess (sorry, "central projection") is plumb on the 2 percent target for the CPI in 2012. We all know, said the Governor, that inflation is going to jump in January, thanks to the combination of dearer fuel and rising VAT, but after that, it should slide gracefully back, wobbling around the target for the next three years.

Key to this projection is the belief that the UK economy could produce a lot more if the demand was there, and the report shows evidence of much effort to try and support this conclusion. Unemployment is one clear indicator of spare capacity, assuming some sort of match between the demands of consumers and the abilities of those without jobs.

More worrying, though, is the dramatic cutback in business investment, as companies have had to put survival ahead of expansion. Some have lost the battle, and others are sufficiently chastened to avoid becoming beholden to their lenders, even if it means passing up attractive opportunities.  The report points out that capital spending fell 10 percent in the second quarter, and the Bank expects it to fall further. Re-stocking should boost output, but it's hardly a sound basis for sustainable growth.

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