BoE's King says monetary policy may have to tackle financial risks

LONDON (Reuters) - Central bankers may need to let inflation undershoot its target in order to reduce the chance of future financial crises, Bank of England Governor Mervyn King said on Tuesday.

In a speech at the London School of Economics, King also referred briefly to the euro zone crisis, comparing it to Germany's struggles to pay war reparations in the 1920s.

"In February 1929, (former BoE director) Josiah Stamp went to Paris ... to assess whether the reparations' debts run up by Germany could be repaid. The similarities with the present situation in Europe are too poignant to dwell on," he said.

He did not address the immediate outlook for Britain's economy, and instead focused on inflation targeting and whether British monetary policy should have been tighter before the crisis.

So-called macroprudential regulatory tools - of the type that the BoE is now getting its hands on - would be the main line of defence against a future crisis, for example by putting a limit on banks' leverage, King said.

But on their own they may not be enough, and future interest rates may have to be set higher than would be needed purely to keep inflation close to the bank's 2 percent target, he added.

"It would be sensible to recognise that there may be circumstances in which it is justified to aim off the inflation target for a while in order to moderate the risk of financial crises," King said.

The BoE governor concluded that higher interest rates in Britain would probably not have been enough to prevent the financial crisis that hit the country hard.

"Much of this was outside the control of UK policymakers and reflected developments in the world economy," he said.

Some economists and parts of the media have criticised the Bank of England for keeping monetary policy too loose in the run up to the crisis, fuelling a credit and house price bubble.

King has served on the BoE's Monetary Policy Committee since the central bank gained operational independence in 1997. His term as governor will end on June 30 next year.

However, financial markets believe the BoE is highly unlikely to raise interest rates from their record low of 0.5 percent before then.

BoE policymaker Paul Fisher said earlier on Tuesday that UK economic output would be broadly flat this year, and the International Monetary Fund on Monday sharply downgraded its forecasts for the UK economy to a contraction of 0.4 percent this year and tepid growth of 1.1 percent in 2013.

A mix of government austerity, the crisis in parts of the euro zone and an overhang of indebtedness from before the global financial crisis are weighing on Britain's prospects, according to the IMF.

(Editing by Susan Fenton)

Source: http://news.yahoo.com/boes-king-says-monetary-policy-may-tackle-financial-173859850--business.html

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