Last updated: November 13, 2012 7:48 pm

Zombies seen to hold back recovery

Rapid price rises alongside a still-feeble recovery surprised economists on Tuesday, but the Bank of England will warn on Wednesday that this might be the shape of things to come.

In speeches over the past month, senior BoE figures have stressed that inflation is a problem and an overhang of debt will impede household spending, business investment and bank lending for some time.



The idea that “zombie” households, companies and banks are holding back the recovery will gain further weight in the quarterly inflation report on Wednesday when the BoE will present research showing most productivity weakness is concentrated in smaller companies.

Though Sir Mervyn King, BoE governor, is unlikely to say so in such stark terms, insiders fear that the recession did not generate sufficient destruction to enable the creation of more productive companies for an upswing.

Even worse for the BoE is that it might be to blame. Some senior figures are questioning whether ultra-low interest rates might have kept zombies alive and prevented the stock of debt falling to levels consistent with recovery.

If true and things continue as they are, Britain is following the path of stagnation suffered by Japan in its post-bubble era since 1990.

The idea is not the settled view of the BoE, but Sir Mervyn and other senior staff worry that with households, banks and companies surviving only because of low interest rates, the country might wake up in five years still with weak growth, high debts and huge economic problems.

At the heart of the new thinking lies the remarkably low mortgage repossession and corporate liquidations in this downturn. With 0.5 per cent official interest rates, banks have been able to allow households and companies to limp along without going under.

In a speech in Wales last month, Sir Mervyn made the point forcefully. “Obviously, this cannot continue indefinitely,” he said. “Policy can only smooth, not prevent, the ultimate adjustment.”

Charlie Bean, the BoE’s deputy governor for monetary policy, went further, saying a long period of subdued demand was inevitable when companies, households and banks sought to repair their balance sheets.

Presenting new evidence to support the thesis from a large survey of households, he said: “It is striking that the sharpest falls in consumption were seen among high income, highly indebted households.”

On Wednesday, the BoE will present evidence saying smaller companies – some seen as zombies – have been the biggest culprits weak productivity.

Professor Fabien Postel Vinay, of Bristol University, who presented at a BoE seminar on productivity last month, says the evidence shows that “small and less productive companies are doing most of the hiring right now”.

Speaking privately, senior figures in the Bank admit the evidence is not conclusive. The small company productivity story does not sit easily with previous BoE research showing the biggest drops in productivity have been in oil and finance, which are dominated by large companies.

The household debt and spending theory is undermined by the fact that rich, high-debt households have also seen the largest falls in incomes.

And even if zombie companies and households are undermining the recovery, senior BoE officials admit that the alternative of mass repossessions, corporate liquidation and surging unemployment is hardly appealing.

So far officials have tried to smooth the adjustment with ultra-loose monetary policy. But if they decide this is postponing a day of reckoning, the question now being raised inside the BoE is whether this is the right strategy.

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