Sir Mervyn King warns risk from eurozone has grown

Sir Mervyn King: "Mark Carney was the outstanding candidate"

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The risk posed by the eurozone has grown, the departing Bank of England governor Sir Mervyn King has warned.

The governor said problems in the eurozone, as well as the US and Asia, lay behind the Bank's recent pessimism about UK growth prospects in 2013-14.

Speaking to MPs, he defended the Bank's decision to pass interest earned on the UK gilts it owned back to the Treasury.

He also said the Bank would be in "very good hands" with his recently announced successor as governor, Mark Carney.

Mr Carney was named by Chancellor George Osborne on Monday as his surprise choice for the new Bank of England head.

Currently the governor of the Canadian central bank, Mr Carney will serve for five years and will hold new regulatory powers over banks.

The UK should take pride, Sir Mervyn said, in not only that it could search the world for the best candidate, but that the country was able to produce a "truly outstanding shortlist" from among its own citizens.

'Slow and protracted'

In evidence to the Treasury Committee, the Bank governor said that Mr Carney - under whom the Bank will be taking on new responsibilities to oversee the health of the country's banks - faced a difficult task.

The new governor

Mark Carney

"There is a great deal of adjustment to be made in the financial sector, a great deal of adjustment to be made in the economy as a whole," he said.

"It may be unreasonable to expect anything other than a slow and protracted recovery absent a further fall in the real exchange rate."

The Bank of England and most City economists say that UK banks must increase their reserves against potential future losses and work their way through problem loans, while the UK economy needs to boost its exports and investment.

The string of difficulties still faced by the UK explained why the Bank chose earlier this month to downgrade the chances of the country experiencing a significant rebound in growth over the coming two years.

"It would take a rather unusual combination of circumstances to see growth of 4% or above in 2013 or 2014," Sir Mervyn said, adding that the recovery would be much more protracted than has typically been the case after previous recessions.

He confirmed that the Bank's decision earlier this month to downgrade its forecasts was due to a change of heart amongst the Monetary Policy Committee, rather than any recent economic developments.

"I think there are times where you debate something and you finally decide: 'Well look, our judgment really has to change now'," he said.

Global economy doubts

The governor said that the biggest drag on the UK came from the weakness of the global economy.

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It is impossible to escape the conclusion that Mr Osborne wants to give a bit of shake to the Bank of England's culture”

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Despite recent positive indications from China and from the US housing market highlighted in the Bank's latest inflation report, the governor expressed doubts.

"I think the staff probably take a more upbeat view on the prospects of the Chinese economy than I would be inclined to," he said.

He also divulged that private conversations with US colleagues led him to doubt the sustainability of the US recovery.

But he expressed his strongest concerns about the eurozone, claiming that - despite a lull in market anxiety over the euro's future - the situation on the continent has become worse over the past year.

"The longer the problem goes on, the bigger the adjustment will need to be," he said, pointing to the continued build-up in debt as southern European governments struggle to regain competitiveness and get their budgets under control.

The governor said that, while the UK economy continued its own adjustment process, the Bank's ability to stimulate recovery would be limited, although he foresaw that further quantitative easing - purchases by the Bank of government debt - may be warranted.

However, he noted that one of his successor's most difficult tasks may be to decide when to start raising interest rates or reversing quantitative easing.

"There's a very difficult policy judgment to be made down the road, first as to when we start tightening monetary policy, and then how rapidly we tighten monetary policy," he said.

Public accounts

The governor was also questioned by MPs about the Bank's decision this month to hand back to the Treasury the surplus income that it earns on government debts it holds as a result of its quantitative easing policy.

He admitted that the timing of the announcement could have been handled better - particularly because the Bank's private knowledge of the agreement had influenced its decision at a committee meeting a few days before the announcement to hold fire on further quantitative easing.

However, he said that the decision did not affect monetary policy or the Bank of England's independence, although he was concerned it could create the appearance that the Bank was acting under the Treasury's influence.

The move would not have any meaningful impact on taxpayers, Sir Mervyn said, and all it would achieve was a change in the way that the government reports its borrowing.

"This is about presentation of public accounts, and I do not want to dissuade you from looking into that and raising it with the Treasury, but it is a matter for the Treasury," he said.

"They are entitled to publish their accounts in the way that they want. And you're entitled to challenge them about whether those accounts are misleading or not."

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