UPDATE 3-BoE’s King urges budget cuts, says rates on hold

* King says Greek debt crisis boosts urgency of budget cuts

* BoE forecasts CPI to return to target even if rates steady

* Euro zone weakness, fiscal consolidation to limit growth

(Adds quotes, details)

By Sumeet Desai and David Milliken

LONDON, May 12 (BestGrowthStock) – The euro zone debt crisis has
made it even more urgent for Britain to get to grips with its
own budget deficit, Bank of England Governor Mervyn King said on
Wednesday, as he backed the new UK government’s fiscal plans.

King said the 6 billion pounds of cuts pencilled in for this
year would help stave off a jump in market borrowing costs, but
the central bank warned that overall risks to growth had
increased over the last three months — due partly to less
stable euro zone export markets.

Tighter monetary policy now looks further off than markets
had thought, after the BoE’s quarterly inflation forecasts
showed inflation would be just below its 2 percent target in two
years time, even if interest rates do not rise.

British government bonds extended gains after King said he
could not rule out a further increase to the BoE’s 200 billion
pounds of quantitative easing asset purchases, though most
economists still view this as unlikely.

King, in a news conference to present the Inflation Report
the day after Britain’s Conservative Party and Liberal Democrats
formed Britain’s first coalition government since 1945, said the
need to up the pace of fiscal consolidation had risen in the
last two weeks.

“The financial crisis is far from over,” he said. “The
banking crisis has turned into a potential sovereign debt
crisis.”

The crisis in confidence that had caused Greek government
borrowing costs to surge had looked set to spread to other euro
zone countries until the European Union and IMF agreed a $1
trillion defence fund at the weekend, King said.

But this did not mean Britain could rest on its laurels as
regarded cutting its own budget deficit, which at over 11
percent of GDP last year was only a bit smaller than Greece’s.

“It is imperative that our own fiscal problems are dealt
with sooner rather than later,” he said.

The Conservatives’ wish to cut 6 billion pounds of
government spending this year, while the Labour administration
wanted to wait until 2001, was a major point of contention in
the run-up to a May 6 election, which left the Conservatives the
largest party but short of an overall majority.

“What is clear is that the Bank anticipates a vigorous
fiscal retrenchment and will closely monitor its impact on the
economy. We therefore do not expect monetary tightening to
commence this year,” said Hetal Mehta, economic advisor to the
Ernst & Young ITEM Club.

RISKS RISE FOR GROWTH, INFLATION

The BoE forecast consumer price inflation would fall more
slowly from its current level of 3.4 percent than it had thought
when it made its last forecasts in February, due to higher
commodity prices and a stronger than expected impact from
sterling’s weakness.

The central bank also said it was worried tight bank lending
conditions meant firms were prioritising cash flow over cutting
prices to boost market share, meaning inflation had not fallen
as much as the spare capacity in the economy might imply.

However, King said it was not possible to conclude that this
was a permanent problem, and remained confident that inflation
would return to target by the end of this year before
undershooting through to 2013.

The new BoE projections show inflation at around 1.4 percent
in two years time if interest rates rise as markets expect, and
just below 2 percent if they are kept steady at 0.5 percent.

Both these estimates are based on former finance minister
Alistair Darling’s budget plans, which the newly elected
Conservative/Liberal Democrat government has pledged to toughen.

The outlook for growth was uncertain, the BoE said, hinging
on euro zone demand, the scale of the boost from sterling’s
fall, the pace of fiscal consolidation and how much banks lent.

“Downside risks to growth have increased somewhat,
reflecting in particular heightened market concerns about the
prospects for fiscal consolidation in a range of countries,” the
BoE said.

By 2012, the BoE forecast the economy would be growing at an
annual rate of 3.6 percent, though total output would be only
just back to its 2008 peak, before the start of Britain’s
deepest recession since the 1930s.

Much of this growth would have to come from exports rather
than domestic demand, said King, who urged those euro zone and
G20 countries with strong economies to consume more imports in
order to boost global economic output.

“It’s not going to be easy,” King said. “It’s going to be a
difficult few years as we face these adjustments.”

Stock Today
(Editing by Mike Peacock)

UPDATE 3-BoE’s King urges budget cuts, says rates on hold