King Says BOE Asset Buying May Start Soon as Rate Effects Wane

By Brian Swint

Jan. 21 (Bloomberg) -- Bank of England Governor Mervyn King said officials may start buying assets within weeks to loosen credit markets as the lowest interest rates since 1694 fail to avert a “marked” recession.

The U.K. central bank may acquire securities such as corporate bonds and commercial paper to bolster lending to companies and consumers as banks rebuild balance sheets damaged by the global financial crisis, King said yesterday. He said interest-rate reductions to the current 1.5 percent won’t prevent a contraction in the first half of the year.

“Despite those big cuts, there remains a risk that inflation will fall below 2 percent,” the target rate, King said in a speech in Nottingham, England. “It is sensible for the Monetary Policy Committee to prepare for the possibility -- and I stress that we are not there yet -- that it may need to move beyond the conventional instrument” of the bank’s benchmark interest rate.

King backed Prime Minister Gordon Brown’s plan to give the Bank of England unprecedented powers to buy securities, unveiled on Jan. 19 along with a 100-billion pound ($140 billion) bailout for banks. Those tools may later be expanded to fight deflation as the British economy faces a recession this year that may be the worst since the aftermath of World War II.

“This is a momentous speech that sets the policy agenda for the next decade,” said Lena Komileva, an economist at Tullett Prebon in London. “More rate cuts are likely but before long, the Bank of England may reach the point of using quantitative easing to target inflation, in effect to prevent deflation.”

Pound, Oil Prices

The pound fell to a record low against the yen yesterday and slipped below $1.40 for the first time since 2001. “Since the summer, the exchange rate has fallen by almost 20 percent, and oil prices have fallen by around two-thirds, both of which will boost demand,” King said in the speech.

“A pronounced contraction in spending and output is under way,” King said. “Total output in the fourth quarter is expected to have fallen sharply. In the first half of this year, the rate of contraction is likely to continue to be marked.”

The inflation rate declined to 3.1 percent in December from 4.1 percent the month before, the biggest drop since records began in 1997. The economy may shrink 2.7 percent this year, the most since 1946, the Ernst & Young Item Club said this week.

“The bank is almost ready, but very willing, to engage in unconventional monetary policy techniques,” said Philip Shaw, chief economist at Investec Securities in London. “There is still some room for interest rates to come down. But there’s a good chance they’ll use this facility.”

‘Adjustment’ Needed

Commercial banks still need to pay down their debts to put their balance sheets in order, King said. “Leverage ratios of large banks remain at remarkably high levels, and the required adjustment will not happen quickly,” he said.

The Treasury said that the central bank can make asset purchases of up to 50 billion pounds and the government will indemnify the bank against any losses, starting on Feb. 2. King said officials “will consider purchasing only high-quality assets” and that any such actions would seek “to complement and stimulate private demand, not substitute for it.”

“In each case the bank will keep the market fully informed,” King said. “It will be a matter of weeks not days before a program of purchases can begin, but it will be weeks and not months.”

Fed Purchases

Any purchases by the Bank of England would follow similar moves by the U.S. Federal Reserve, which has started buying securities after cutting its benchmark interest rate to a target range of zero to 0.25 percent.

Policy makers will watch measures of lending to non- financial companies to gauge how well the asset purchases and the government’s capital injections and loan guarantees are working, King said.

The measures “are not designed to protect the banks,” King said. “They are designed to protect the economy from the banks.”

The economy may still take some time to recover, he said. “The lags in economic policy are notoriously long and unpredictable. But well-designed policies implemented within a consistent policy framework will eventually work.”

To contact the reporter on this story: Brian Swint in London at bswint@bloomberg.net.