BoE warns govt to keep fiscal policy under control

Bank of England Governor Mervyn King warned the government on Thursday not to allow its spending to get out of control or start underwriting new mortgage lending as Britain nears its first recession since the early 1990s.
The Labour government, well behind in opinion polls to the opposition Conservatives and expected by many analysts to lose the next election due in 2010, is under growing pressure to ramp up spending to help households cope with the economic downturn.
Finance minister Alistair Darling has said the government can allow borrowing to rise, but King said on Thursday failing to keep fiscal policy credible could boost inflation expectations and make the central bank's job harder.
"The long-term risk is a fiscal framework that is not perceived by financial markets to be credible does put up pressure on inflation expectations because it undermines the market's belief in the credibility of both the monetary and the fiscal framework," King told parliament's Treasury Select Committee.
"And that will make our life more difficult if inflation expectations were to remain higher than we would wish."
"There are two challenges which are confronting fiscal policy at present," King said. "The assumptions on which some of the medium term revenue projections were made … now look a little optimistic.
"The second is that the underlying fiscal balance may have balanced over the cycle over the past 10 years, but it was clearly more in surplus in the first half and more in deficit in the second. So, in order to get to a sustainable medium term path for the public finances, these two issues need to be confronted."
King's comments drew criticism from lawmakers on the committee who accused him of stepping outside of his remit and trying to tell Darling what to do.
The governor also said that the government should be wary of caving into pressure to underwrite new mortgage lending to help revive the flagging housing market.
"If they were to do that, there would be some source of additional mortgages … but what that would do is totally undercut the incentive of private sector banks to get their own balance sheets back in order."
King said Darling had an open mind on what can be done to revive the subdued mortgage market. The government-sponsored Crosby report, which will contain recommendations on what can be done to ease mortgage market conditions, is expected in the coming weeks.
King told the committee that the BoE would announce how it intends to provide further liquidity help to the financial system when its Special Liquidity Scheme closes on Oct. 21.