Bank turns gloomy on recovery

 
By Claire Jones and Chris Giles
 

The Bank of England’s output forecasts are now gloomier than at any time since it gained independence in 1997, in part because “zombie” companies propped up by low interest rates have remained undead long past their sell-by date.
 
UK economic output has barely budged since 2010. But until Wednesday’s Inflation Report, the BoE had factored in the possibility of a period of rapid growth in the coming years to make up for the dire performance of the economy since the crisis hit.
 
 
It now believes the recovery will struggle to gain momentum, with the monetary policy committee expecting growth to remain below its pre-crisis trend for the foreseeable future. “After a period of a year of reflecting on all this, we have decided that we think the chances of a rapid recovery are a good deal less than we thought,” Sir Mervyn King, the governor of the Bank, said.
 
Sir Mervyn maintained that most of the blame lay in the poor health of the global economy – often cited by the governor as the prime cause of Britain’s woes. But on Wednesday, the BoE noted another important factor: the number of “zombie” companies kept in business by its ultra-loose monetary policy and lenders’ reluctance to write-off bad loans.
 
 
Roughly three out of 10 companies in the UK are now making a loss; more than during the recession of the early 1990s. But the number of insolvencies this time around is far lower. Though the number of liquidations shot up in 2008, they have fallen since and the BoE expects 16,800 companies to close their doors this year – substantially lower than the almost 25,000 that went out of business during the early 1990s. Even during the peak of the 2008-09 recession, the number of liquidations was less than 20,000 a year.
 
Senior BoE officials have mixed feelings about the “zombie” phenomenon. More companies remaining in business will help support demand. But concern is growing in the upper echelons of Threadneedle Street that the lack of creative destruction – the process by which capital is put to its most efficient use by businesses with no future closing and more viable prospects attracting investment – will hinder longer-term growth. The BoE said in Wednesday’s report that the phenomenon could be a factor in the fall in productivity of recent years, which has particularly afflicted the UK’s smallest companies.
 
Spencer Dale, chief economist, characterised the differing views within the bank. Commenting on the low rate of insolvencies, Mr Dale said: “To some extent, that’s exactly what we want to happen, that’s the whole point of monetary policy loosening at the moment – to keep companies that have a viable long-term future in business while demand is temporarily weak . . . However, it also does have an element [whereby it stops] the natural process by which companies that don’t have sustainable business models may be kept in business for longer.”
 
It is not just businesses that remain undead: there are also “zombie” households. Sir Mervyn and Charles Bean, the BoE deputy governor, have both cited households’ high debt levels as a reason for poor consumer spending, which the governor flagged as one of the most important reasons for the economy performing far more poorly in the past two years than the BoE had expected in 2010.
 
The conundrum for the MPC lies in working out whether to tighten policy – and risk killing off viable businesses and grappling with the fallout from a rise in home repossessions – or preside over an economy littered with the walking dead by keeping rates low. If the committee gets it wrong, growth could come in even poorer than Wednesday’s forecasts.

Copyright The Financial Times Limited 2012.