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Mervyn King: Time to Review Inflation Target

Wednesday, 23 Jan 2013 | 4:26 AM ET
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The Bank of England's inflation-targeting remit needs to be fine-tuned but should not undergo fundamental change, central bank governor Mervyn King said in a wide-ranging speech on Tuesday.

King also said the central bank was ready to restart bond purchases or cut interest rates if needed to boost the economy, but that Britain needed more fundamental reforms if it was to exceed the "gentle recovery" which he expects for 2013.

King steps down in June, and his successor Mark Carney, who currently heads the Bank of Canada, has promoted long-term commitments to low rates - which are also in favor at the U.S. Federal Reserve - as well as discussing the merits of targeting the size of the economy in cash terms instead of inflation.

To date the Bank of England has been unenthusiastic about explicit interest rate commitments - arguing its existing policy framework is clearer than other central banks'.

And finance minister George Osborne, who ultimately decides the bank's goals, said last month that while he welcomed debate, there would need to be a strong case for change.

However, in what is likely to be his last speech outside London, King told members of Belfast's business community that it was time for the BoE and the government to think again.

"Recent actions by central banks and governments in a number of industrialized countries have raised questions about the frameworks within which monetary policy is being conducted," he said.

"In the UK, the inflation target was introduced almost 21 years ago, and it has now come of age. It would be sensible to review the arrangements for setting monetary policy," he continued at the Confederation of British Industry event.

The changes King appears to have in mind are relatively small. In the speech, a text of which was provided by his office, King said Osborne may want to be more explicit about how fast the central bank is expected to return inflation to target.

Inflation has been above its 2 percent goal since December 2009, and King said he expected it to remain so for most of 2013. The central bank's forecasts do not see it firmly back at 2 percent until the second half of 2014.

This is in line with the bank's current interpretation of its mandate, under which it sets monetary policy to get inflation to 2 percent within 2-3 years.

King also referred to the Fed's decision to state levels which unemployment would probably need to fall to before it started to raise interest rates.

"Is there a gain from trying to quantify how the (bank's) Monetary Policy Committee should manage the trade-off between growth and inflation in the short run?," King asked.

"How much discretion to give to the MPC and how much should remain with the Chancellor is an interesting question that was raised, but not fully resolved, in 1997," he added, referring to the date when the BoE gained operational independence.

Earlier on Tuesday, former MPC member Adam Posen argued against both long-term policy commitments - saying markets did not take them very seriously - and targeting nominal GDP, saying it would lead to higher inflation than inflation-targeting.

No Policy Panacea

In his comments about the more immediate outlook for British monetary policy, King left his options open, though his remarks are unlikely to change economists' expectations that the central bank will not add to its 375 billion pounds ($595 billion) of asset purchases any time soon.

"We are ready to provide more stimulus if it is needed," King said, adding the bank would continue to assess whether to cut interest rates again - something it has resisted since March 2009 lest it hurt fragile banks or building societies.

Although inflation was likely to remain above target for most of 2013, the MPC could look past this while it was driven by semi-regulated prices like university tuition fees rather than market-generated price rises, King said.

Nonetheless, more asset purchases or rate cuts would not be enough to get Britain's economy back on track.

"Relying on generalized monetary stimulus alone ... is not a panacea," King said.

Britain's economy shrank around 6 percent in the 2008-09 financial crisis, and has recovered much more slowly than its peers. Growth in the last three months of 2012 was likely to have been "considerably weaker" than in the previous quarter, continuing a trend of zig-zagging growth rates, King said.

A more solid recovery required three things, King said, citing supply-side reforms, stronger euro zone growth and restructuring Britain's banks.

Some banks needed more capital and others - like state-controlled Royal Bank of Scotland and Lloyds Banking Group - would benefit from selling non-core assets and a prompt return to private ownership, King said.

"With proper implementation, there is no reason why the two banks with significant state shareholdings could not largely be back in the private sector within a relatively short period," King said.

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