Markets poised for severe fall, says King
The Bank of England Governor has issued an extremely unusual warning on world stock markets, indicating that shares may be heading for a major fall.
Mervyn King said the full impact of the credit crunch had not yet been felt on equity markets in the West and in developing countries, saying that the possibility of share price falls were one of the biggest risks facing the world economy.
His warning came as the Bank gave a firm indication that it plans to cut interest rates as many as three times over the next two years to protect Britain's economy in the wake of the credit crunch. The signal caused the pound to drop to a four-year low against the euro, with the single currency now worth 71.13p.
"It is very striking that despite the developments we've seen in the last three months , despite the stresses and strains in the banking sector , equity prices are higher now than they were in August," he said, unveiling the Bank's Inflation Report, which said the strength of share prices had been "surprising".
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He added: "This is true around the world, and in emerging markets they're 20pc higher. There must be some downside risks there.
"That's factored into our projections. That's the bigger risk to the global economy than the narrower one focused on the banking sector."
The Governor's warning echoes the Bank's recent Financial Stability Report, which said that the UK stock market is "particularly vulnerable" to a downturn. It is highly unusual for a central banker to comment directly on share prices. One of the most renowned examples was former Federal Reserve chairman Alan Greenspan's comment about "irrational exuberance" in the US stock market in the 1990s.
Mr King said: "The repricing of risk hasn't really fed through to equity markets, and if there were to be an adjustment of risk premia in equity markets with a fall in asset prices then that could have a bigger impact on the world economy."
His warning was echoed by Stuart Gulliver, global head of investment banking at HSBC, who said equity markets are not reflecting the prospect of slower growth ahead.
The Governor also issued an unexpectedly severe warning on currency markets, expressing "major concern" over the effects China's dollar peg is having on worldwide exchange rates and economies.
He said: "The difficulty in the world economic system at present is that a number of major economies have flexible exchange rates... others, like China, have linked theirs to the dollar and that is causing great currency tensions.
"I came away from the [International Monetary Fund] meeting more concerned about the implications of these tensions, because the unwinding of [global economic] imbalances is not just a hypothetical prospect, but is happening now. And I think this is a major concern."
The dollar recently slumped to a 26-year low against sterling, and has hit record levels against the euro. Many experts feel the impact of its devaluation has been intensified by the Chinese refusal to loosen its currency's peg.
The Bank cut its growth forecast for next year from around 2.8pc to 2.2pc, though some economists said even this was optimistic.
A number have now forecast that it will deliver the first of its rate cuts as soon as next month.
Mr King said he had not considered resigning over the Northern Rock crisis, and denied that the UK financial system had been damaged by the episode.
"The underlying structures are sound," he said. He added that he was confident that UK banks would weather the coming storm, as they calculate their losses, saying: "The big five banks have made over the past few years about £100bn of profits.
"If ever there was a moment when it was helpful for banks to have made large profits it must be now.
"They will provide the cushion which guarantees the stability of the banking system and it is strong and stable." inside
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