Blanchflower Says U.K. Needs Rate Cuts as Deflation Risk Looms

By Brian Swint and Jennifer Ryan

Oct. 30 (Bloomberg) -- Bank of England policy maker David Blanchflower said U.K. interest rates need to fall soon and ``significantly'' to stave off the threat of deflation as the economy endures a recession throughout the next year.

``Interest rates do need to come down significantly -- and quickly,'' Blanchflower said in a speech at the University of Kent in Canterbury, England, yesterday. ``If rates are not cut aggressively we do face the prospect of a relatively deep and long-lasting recession.''

The Federal Reserve cut its interest rate to 1 percent yesterday and said that downside risks to economic growth remain. Blanchflower has argued that the U.K. economy faces similar conditions to the U.S. and voted for a rate cut at every meeting in the past year, pressing for a half-point reduction to 4.5 percent before the Bank of England delivered it this month.

``U.K. output will continue to contract in 2008 and 2009,'' Blanchflower said. ``My concern is that inflation will be below 1 percent -- and maybe even negative.''

Inflation accelerated to 5.2 percent in September, the fastest pace in at least 11 years. The bank predicts it will soon start to slow toward the 2 percent target.

The Monetary Policy Committee voted unanimously to lower the interest rate on Oct. 8 after the financial crisis crippled the British banking industry. It will cut the rate by a further half point at the next scheduled meeting on Nov. 6, according to the median forecast of 30 economists in a Bloomberg News survey.

Darling's Pledge

The crisis has forced Chancellor of the Exchequer Alistair Darling to buy stakes in banks, raising spending. He signaled late yesterday that the Treasury will pay down debt once the economy recovers. The European Investment Bank will lend 4 billion pounds ($6.6 billion) to U.K. companies struggling to borrow because of the credit crunch, the Treasury said today.

Monetary policy has so far not been ``sufficiently forward looking'' and it has been ``apparent for some time'' that the U.K. is in a recession, Blanchflower said.

While other policy makers have argued that accelerating inflation will encourage Britons to push for higher wages, Blanchflower said that price expectations will fall. ``The British people are smart enough to have actually noticed that inflation is coming down fast,'' he said.

The pound's depreciation won't be inflationary because it will be offset by the more than 50 percent drop in oil prices since then, Blanchflower said. Companies would also have trouble passing on any higher costs as demand weakens, he said.

Job Losses

Jobless claims rose to the highest level in almost two years in September, the statistics office reported Oct. 15. The U.K. economy shrank 0.5 percent in the third quarter, the largest contraction since 1990.

Blanchflower said that happened before the global financial crisis flared up, following the collapse of Lehman Brothers Holdings Inc. in September. The intensification of the credit squeeze that followed ``has yet to be fully felt'' by companies and households, he said.

The current financial crisis may turn out to be ``more significant'' than the aftermath of the 1929 stock market crash, Blanchflower said. Still, ``it is a mistake to be overly gloomy'' because ``Britain's economy will, eventually, recover,'' he said.

In questioning after his speech, Blanchflower said that policy makers need to guard against ``systemic failure'' of the banking system. ``We're not out of the woods yet,'' he said.

Policy makers may need to reconsider how to cope with rising asset prices while consumer-price inflation remains subdued, Blanchflower said in his speech.

``The key economic policy over the last decade has been the unsustainable rise in asset and equity prices and the associated credit boom,'' Blanchflower said. ``Does mainstream theory have an adequate explanation of why things have gone so badly wrong? It is not clear that it does. It may well be time for a rethink.''

To contact the reporters on this story: Brian Swint in London at bswint@bloomberg.net; Jennifer Ryan in London at jryan13@bloomberg.net.