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http://www.cnbc.com/id/32354233

Bank of England to Warn of Deflation: Report

Published: Monday, 10 Aug 2009 | 1:13 AM ET Text Size By: Reuters

The Bank of England will downgrade its growth forecasts and issue a warning this week that the UK economy risks slumping into a debt deflation trap, the Telegraph reported on Monday.

The newspaper said BoE Governor Mervyn King will use the Bank's Inflation Report on Wednesday to say the risk of such a slump was one of the main reasons behind the bank's surprise decision last week to extend its quantitative easing programme.

The paper also cited former BoE monetary policy committee (MPC) member Sushil Wadhwani — now a hedge fund manager — as saying the current apparent upturn in the UK economy may be wiped out by another downturn next year.

Wadhwani told the Telegraph he saw growing evidence the UK was tracking a similar path to that of the Japanese economy in 1990s, which apparently recovered from its initial economic crisis only to fall into stagnation for decades.

"The recession is over, in the sense that you will probably now get three to four quarters of a decent bounce — just as Japan did in the early 1990s," Wadhwani told the paper.

People think things will then return to normal — but these bounces are driven by temporary factors." "The second half of 2010 could be more difficult for the UK than 2009," he added.

"There will be a big fiscal tightening, the VAT (value added tax) cut will have gone; and the world as a whole will be slowing at that point. You will have several things coming together which will dampen the economy."

The BoE stunned markets on Thursday with a 50 billion pound increase in its quantitative easing (QE) programme to 175 billion pounds ($293 billion).

The Bank's policymakers said weak economic conditions and tight credit warranted a large expansion to keep inflation on track to meet their 2 percent target, suggesting their new growth and inflation forecasts next week will be gloomy.

The Telegraph said Wadhwani's warning was likely to be echoed by King, who will say that although the worst of the recession is now passed, the knock-on effects on lending to companies and individuals mean the recovery will feel almost as painful as the downturn.

It said King would refuse to rule out extending the QE scheme beyond the 175 billion pound level set by the MPC this week.

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