Tim Besley, the Monetary Policy Committee hawk who tried to push through a rise in benchmark UK interest rates in August, admitted last night that the prospects for consumption and the overall economy were weak and inflation risks had "diminished significantly".
Besley's acknowledgement of the rapidly-deteriorating economic position, in a speech at Swiss bank UBS's conference centre in London, will fuel hopes that this month's half-point cut in UK base rates to 4.5% will be followed swiftly by further significant reductions.
However, Besley warned the "transmission" channels between cuts in base rates and the real economy were "impaired" and an "element of patience is required" in terms of such monetary policy measures impacting on economic activity.
And monetary policy, he argued, could only help "meet the current challenges" in conjunction with measures such as the ongoing recapitalisation of the banks and liquidity operations aimed at restoring normality to credit markets.
Besley, a professor at the London School of Economics, highlighted a raft of pressures weighing down on household spending.
And he noted: "Given that consumption accounts for around 70% of national spending, the prospects for consumption will have a material impact on the path of the economy in the coming months."
In a rapid about-turn, Besley has moved from pushing unsuccessfully for a quarter-point rise in UK base rates at the July and August meetings of the Bank of England's nine-strong MPC to opting for the status quo in September and then to endorsing the committee's half-point cut to 4.5% on October 8.
Besley's erstwhile hawkish stance pitted him against fellow external MPC member David Blanchflower, who has pushed consistently in recent months for cuts in interest rates and voted in vain for a half-point reduction in September.
Blanchflower had felt the inflation danger was being overstated given the building threats to economic activity, and recent events have shown he was entirely correct in this view.
Besley, although noting benchmark annual UK consumer prices index inflation had risen to 5.2%, spent most of his speech last night dwelling on the weak economic outlook and explaining his volte-face.
He said: "As you will know, there was a time last summer when I judged the upside inflationary risks to be sufficient to warrant an increase in Bank Rate to head off the prospect of persistent inflation. But since then, the sharp fall in commodity prices and the consequently more benign prospects for food and services inflation, as well as the substantial weakening in demand, imply that the upside risks to inflation have diminished significantly.
"Conditions in credit markets are likely to remain tight ahead of the full effects of recent government initiatives working their way through to the terms faced by borrowers. It is now less likely that the rebalancing process for the UK will be as gentle as thought one year ago."
Besley also told his audience: "There is much uncertainty about the path that the economy will now take and how severe and prolonged the decline in living standards will be."
He also declared the "anxiety level is high", given people had been accustomed to economic stability "for some while now".
Mulling the outlook for UK consumer spending, Besley declared there were "good reasons" to believe consumption "will be weak in the near term".
He said: "The fundamental drivers of consumption include the prospects for growth in real incomes - not just in the short run but also over the longer term. The former (short-run prospects) are clearly weaker and are definitely more uncertain."
Although noting the recent fall in commodity and energy prices would, if sustained, support some growth in real incomes, Besley added: "But access to credit is also a crucial determinant of consumption and is likely to be a significant determinant of consumer behaviour in the next year or so."
He saw two key drivers of higher household saving and reduced consumption.
Besley said: "In the mortgage market, many borrowers, especially those requiring high loan-to-value ratios, are effectively rationed out of the market.
"This is unlikely to end until house prices stabilise and first-time buyers have accumulated sufficiently large initial deposits to reflect greater caution on the part of lenders. The latter is likely to come mostly from increased saving."
Besley also noted people were likely to save more because they no longer had the same access to mortgage equity withdrawal. He said: "There are good reasons to think that lenders will be more reluctant to support such behaviour (equity withdrawal) for many borrowers going forward as the value of housing collateral falls. This may also weigh down on consumption growth since prudent consumers will find it more necessary to hold larger levels of savings as a cushion against unforeseen events."
Besley added: "Through both of these channels, household indebtedness is likely to moderate and saving to increase ... This, alongside weaker prospects for real income growth, is likely to weigh down on the growth of demand in the near term, and possibly beyond."
Besley cited "much discussion right now about the right level of interest rates in the current situation and the likely impact of cuts in Bank Rate on the economy".
And he cautioned: "As long as credit availability is limited and the adjustment that I have just described is underway, I would not expect consumption to be particularly responsive to the level of interest rates. What matters is that the policies directed towards restoring more normal conditions in credit markets are effective. Given time to work, these should also lead to households and businesses feeling more confident about spending and investing."
Although noting a "cut in Bank Rate, on its own, will not be a magic bullet", Besley said: "As the impact of recent policy measures begins to have their desired effect, these traditional channels of monetary policy effectiveness will resume their role in transmitting policy decisions to economic activity. However, an element of patience is required."
