The Bank of England is ready to inject more cash into the fragile British economy if recent positive signs fade, BoE Governor Mervyn King said on Tuesday, noting fresh dangers from a slowdown in emerging economies.
King rejected calls for other forms of policy stimulus, such as giving money directly to the government and households or cancelling the gilts the central bank holds, saying that combining monetary and fiscal policy was "dangerous".
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While he left the door open for more quantitative easing purchases of government bonds in November, King stressed that central bank support could not forever postpone the necessary adjustments in an economy dealing with a massive debt overhang.
"One thing we can see clearly is that the recovery and rebalancing of the UK economy are proceeding at a slow and uncertain pace," King said, according to the text of a speech he was due to deliver at an event in the Welsh capital of Cardiff.
"At this stage, it is difficult to know whether some of the recent more positive signs will persist," he said.
"The Monetary Policy Committee will think long and hard before it decides whether or not to make further asset purchases. But should those signs fade, the MPC does stand ready to inject more money into the economy," King added.
Most economists expect the central bank to extend its total asset purchases beyond the currently approved 375 billion pounds once the latest 50 billion pound round is completed next month.
However, three of the nine policymakers have indicated their reluctance to vote for more stimulus as they worry about the inflation outlook, and only one - David Miles - has made his support for more stimulus clear.
King said gross domestic product was much weaker over the past two years than expected. On the other hand, companies created more jobs than over any other two-year period since the mid-1990s, he said.
In addition, a fall in inflation eased the squeeze on Britons' incomes and recent retail figures were consistent with a pick-up in consumer spending, King said.
But he added that recent rises in energy and food prices would keep inflation above the 2 percent target well into 2013.
Britain's economy probably posted some growth between July and September and exited recession after three consecutive quarters of contraction.
However, a string of weak business surveys have raised concerns about an immediate relapse as the economy still faces headwinds from the government's austerity drive, the euro zone debt crisis and tight credit conditions.
And King said that the "storm clouds" from the euro zone debt crisis had not yet lifted and new clouds were drifting over from other parts of the world, as major emerging economies China, India and Brazil were all slowing.
The central bank governor reiterated his view that the BoE could help to smooth the necessary adjustments but not prevent them from happening.
The central bank's role was to create enough money to support sustainable growth at the target rate of inflation, King said. "We are not doing it at the behest of the government to help finance its spending," he said.
King rejected calls for any direct financing of government spending or giving out money to households as so-called "helicopter money".
Such policies could blur the lines between monetary and fiscal policy and lead to uncontrolled inflation. "Not only is combining monetary and fiscal policies unnecessary, it is also dangerous," he said.
In this context, King also rejected the idea of cancelling the gilts the central bank bought as part of its quantitative easing program.
"The Bank must have the ability to reverse its policy -- to sell gilts and withdraw money from the economy -- when that becomes necessary," he said.
King said the central bank's new Funding for Lending Scheme, which provides banks with cheap funding if they keep up lending to businesses and households, had helped to bring down banks' funding costs.
"The effect of the FLS will be seen in the lending data only after some months because of the time it takes for banks to change their lending strategies and for data to be collected and published," King said.
Banks were now awash with liquid assets, he said.
"Their problem remains insufficient capital," he said. "Just as in 2008, there is a deep reluctance to admit the extent of the undercapitalization of the banking system in many parts of the industrialized world," he said.