Mervyn King's salvo first in wider war

Mervyn King has fired what could be the first salvo in a wider war.

By Hugo Dixon, breakingviews.com
Last Updated: 1:32PM GMT 25 Mar 2009

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The Bank of England governor’s warning that the government can’t afford another big fiscal boost should be seen as an attempt to avoid no fewer than three crises that could be looming: a fiscal crisis, a constitutional clash and an inflation crisis.

The budget crisis is the most obvious one. The UK’s fiscal deficit will in the next financial year rise to 11pc of GDP, according the latest International Monetary Fund forecast. Fortunately, the UK’s public debt isn’t terribly high. So it can probably carry an annual deficit this big, at a pinch, for a year or two. But if such humungous deficits continue for several years – let alone get larger - there is a risk financial markets could lose faith in the economy. International investors wouldn’t just send sterling lower; they could also refuse to buy government bonds.

Such a fiscal crisis must be one of King’s nightmares, not only because it would be bad for the country but because it could trigger the second crisis: a constitutional clash. The BoE has just embarked on its policy of quantitative easing, under which it is creating money to buy government bonds with the aim of boosting the economy. This policy is risky enough as things stand. But, if investors in gilts went on a buyers’ strike, the BoE would be left as the only purchaser of government bonds. King would then have an uncomfortable choice: print yet more money to hand to Gordon Brown, the prime minister, a policy that would lead to a total debasement of the currency; or refuse to bail out the government.

Even if these scenarios don’t materialise – and, at present, they must be viewed as “tailâ€