–Adds Detail, Quotes To Earlier Version
–Liquidity Support Just Buying Time For Greece, Not Solving The Problem

LONDON (MNI) – The Bank of England Governor Mervyn King said he
expects lending spreads to narrow when Bank Rate is hiked, but also said
the majority of the BOE’s Monetary Policy Committee had voted against a
hike because of concerns it would create output volatility.

If spread compression does occur after a rate hike, it means the
impact of that hike would be cushioned. King said that the MPC was
acting in line with its remit in not tightening policy despite current
high inflation outturns.

The BOE Governor, in evidence to the Treasury Select Committee,
once again attributed current high inflation outturns to import cost,
tax hikes and energy price increases.

“Our task is to meet the remit set by you (parliament) and that
remit does allow for us not to try to bring inflation back to the target
immediately if that would lead to undesirable volatility of output,” he
said.

“I think most of us on the committee have taken the view that to
tighten policy now would be to risk that,” King added.

On his own policy stance King said “I voted for no change. I
haven’t voted for an increase in asset purchases. But I think the
differences between members of the committee are easy to exaggerate.
After all, the differences range only from whether interest rates should
rise by a quarter of a percentage point now to whether there should be
an extra stg50 billion of asset purchases.”

He said the MPC policy divisions were “within the broad context of
a position in which inflation is clearly uncomfortably high and this is
represented as a symptom, it is not a cause it is a symptom, of a very
substantial squeeze on real living standards.”

“I am definitely concerned by … the squeeze on real income. I
don’t believe it is easy to do much about that,” King said.

“This is the way in which we as a country are adjusting to the
consequences of a crisis, and the macro economic rebalancing that is
necessary to get through that,” he added.

Contingency Planning For Greek Default

In the early part of his evidence to the Treasury Select Committee,
King was grilled about the likelihood of a Greek default. He refused to
be drawn on the probability of a default, but said it was high enough
for the BOE to have put in place contingency plans.

“I personally don’t ascribe a risk to Greek default. It is not for
me to do,” he said.

He noted that the BOE’s Financial Stability Review assessment
showed the market “ascribes a probability of 80% to some aspect of
default.”

“The more important thing (than guessing how likely a Greek default
is) is to try and tackle the underlying problems,” King said.

With the market placing a high probability on default that is
enough “for us to think carefully about contingency plans and the
consequences of a default.”

The BOE head said the current problem “goes much wider than just
the euro area.”

He said the crisis stemmed from unsustainable national borrowing
patterns before the financial crisis and “What the crisis revealed ….
was this was unsustainable and couldn’t carry on.”

“If you have a very large net external debt and you want to
continue to service that debt, the only way to do it is to run trade
surpluses,” King said.

This lesson of economics “applies to us. But it particularly
applies to the euro area and it is up to them to find a way through it.”

King said one of the message he was delivering when he presented
the Financial Stability Review last Friday was that liquidity
support, to Greece and elsewhere, was just a way of buying
time.

“Providing liquidity support may buy time to put in place a
long-term strategy, under which this competitiveness can be regained.
So far the time that has been bought by the provision of liquidity has
not really been used to put in place programmes that can guarantee
significant improvement and competitiveness,” he said.

“Buying time is not sufficient, that time has to be used,” he
added.

“I don’t think that buying time appears attractive
very often because the immediate crisis appears to go away. Youl get
to bed earlier, you’ll relax more. But in fact the underlying problems
have not changed, the crisis comes back in more severe forms and that
has been the case going through the past 18 months in trying to deal
with Greece, Portugal and Ireland and indeed the problems for the euro
area as a whole,” he said.

–London newsroom: 4420 7862 7491; email: drobinson@marketnews.com

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