(Adds details, comment) By Natasha Brereton Of DOW JONES NEWSWIRES
LONDON -(Dow Jones)- U.K. Business Secretary Vince Cable said Wednesday that aggressive monetary policy is necessary to support demand as the government undergoes its fiscal austerity push, amid a sharp fall in business investment.
In a speech in London, Cable said that a combination of supply- and demand-side measures were needed to sustain U.K. economic growth. But he noted that the supply-side steps, including corporate tax measures, deregulation and an aggressive approach to training, were focused on the longer term and wouldn't have an immediate impact on growth.
"Implicitly, there is an understanding that monetary policy will accommodate what we're trying to do and will help to sustain aggregate demand," Cable said, acknowledging the Bank of England's independence in this arena.
"The assumption is that aggressive monetary policy can sustain demand," he added.
The BOE in February suspended its GBP200 billion quantitative easing policy of buying bonds with freshly created central bank money, but has left the door open to extending purchases if conditions deteriorate.
It has kept its key interest rate at an all-time low of 0.5% since March last year.
Cable said that improving the supply of credit was key to supporting economic growth, and noted that a vigorous debate was underway about how far the contraction in the banking sector is constraining output.
He said he believed there was a supply problem, as banks have adjusted lending policies to account for risk aversion, which has pushed up the cost of borrowing, in turn reducing demand for funding.
"It is actually and I think potentially a very, very severe constraint. And probably more than any other single factor--unless we deal with it--could prevent recovery," Cable warned.
He pointed out that the steep refinancing hump that banks face over the next couple of years, including the expiry of BOE's Special Liquidity Scheme in 2012 "if it goes according to schedule," would aggravate the situation, unless action was taken.
"There is a big debate, unresolved, which we're in the middle of, in terms of how we resolve this constraint," involving how to put macroprudential and countercyclical principles into practice now we're at the bottom of the financial cycle, Cable said.
"Do we use large-scale guarantees to reduce risk in the margin? Or do we use quantitative controls over lending?" he said.
The BOE has estimated that the U.K.'s largest banks will need to refinance or replace GBP750 billion to GBP800 billion of term loans and liquid assets by the end of 2012.
In response to an audience question on whether the U.S. idea of government guarantees for small business lending might provide a useful model, Cable said they "may well be part of the solution," noting that such a scheme already exists in the U.K.
"One question going forward is how far we need to expand those guarantees and how far we can, given of course that it all adds to the contingent liabilities of the government," he said.
Copyright 2009 Dow Jones Newswires
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