Monetary Policy Committee member Kate Barker last night said her chief concern was a "significant possibility of a large downside risk" to UK growth from the global credit crisis, yet appeared determined to temper expectations of further interest-rate cuts.
Barker's messages were contained in a speech entitled Policy Dilemmas, released by the Bank of England, a version of which was delivered to the North Staffordshire Chamber of Commerce last night.
She also warned of the danger of a fall in UK house prices. Barker said the scale of the nominal 211% rise in house prices since 1997, which nearly doubled the house price-to-earnings ratio, was "difficult to justify", even with the accompanying fall in long-term real interest rates and easing of credit conditions up until the crunch last summer.
However, she played down the impact of falling house prices on consumer spending.
She said: "It is worth noting that it has been calculated, on a very pessimistic assumption of a fall in house prices of 15%, that only 5% of mortgagors, around 2% of households, would find themselves in negative equity."
However, she highlighted a greater danger if the credit crunch were to cause mortgage providers to rein in lending for a prolonged period.
Barker said: "A prolongation of the present difficulties in accessing wholesale funds could restrict the quantity of mortgage lending during 2008.
"In this case, the mortgage market could become less competitive and more expensive, feeding back into a decline in the housing market, somewhat lower consumer spending, and also into lenders' balance sheets, reducing lending capacity further.
"A similar risk exists with regard to commercial property and the balance sheets of both borrowers and lenders."
She added: "If these risks were to crystallise to any great extent, there would be clear potential for much weaker output growth as reduced credit availability would adversely affect both consumption and companies' ability to invest.
"This would also tend to result in lower inflation in the medium term than the MPC's present central projection."
However, in spite of these concerns and her comment that the MPC could "support the government's objectives for growth and employment" subject to it achieving its 2% inflation target, Barker cited rising energy and food prices and declared: "Unfortunately, the strong upward inflation pressures in the UK today make it difficult to argue for large reductions in Bank Rate to reduce this downward risk."
She also noted that any lasting rise in people's future inflation expectations could be "very costly to reverse".
The MPC cut UK base rates by a quarter-point on December 6 and again on February 7 to take them to 5.25%.
Barker said: "My chief concern is the significant possibility of a large downside risk to growth, and therefore to inflation, as the impact of the credit tightening works through the economy.
"I rate this a little higher than a large upside risk to inflation over the medium-term from dislodging inflation expectations on the upside. And the change in credit conditions themselves means that any given level of Bank Rate is somewhat more restrictive.
"However, while this might suggest an immediate case for lowering interest rates further, it is not compelling."
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