Bank governor warns: 'We cannot afford any more stimulus plans'

Intervention threatens Prime Minister's hopes for Budget and G20 summit

The Governor of the Bank of England, Mervyn King, has hijacked next month's Budget and ruled out a further fiscal stimulus to the economy – the very policy Gordon Brown is campaigning for in advance of the G20 summit in London next week. Such open defiance of Downing Street by Threadneedle Street is unprecedented in modern times.

Mr King told the Treasury Select Committee yesterday that, while the recession would mean that "very large" budget deficits would have to be tolerated for some years, there was little scope for further, "discretionary" increases in borrowing, similar to the £20bn package announced by the Chancellor in last November's pre-Budget report.

Mr King told MPs: "Given how big those deficits are, I think it would be sensible to be cautious about going further in using discretionary measures to expand the size of those deficits ... The level of the fiscal position in the UK is not one that would say, 'Well, why don't we just engage in another significant round of fiscal expansion?'"

Last week the IMF said that the UK's budget deficit would rise to around 11 per cent of GDP next year – or £165bn, against a Treasury forecast of £118bn. It will be the highest in the G20. The Treasury is already constrained by that: tiny increases in public spending – 1.1 per cent a year in real terms – are planned from 2011 and economists are warning about an inevitable £25bn of tax rises – whoever wins the election.

Mr King's intervention may well irritate 10 Downing Street on at least three grounds. First, that Mr King is ruling out the very fiscal stimulus that the Prime Minister is publicly committed to and trying to persuade the German government to agree to. Second, that Mr King has seemingly overstepped the traditional line between Treasury matters to do with budgets and public spending and the Bank's remit of financial stability and monetary policy. Central bank governors do not usually offer the benefit of their wisdom in such a public fashion as Mr King chose to yesterday, and he added: "I'm sure the Government will want to be cautious in this respect. There is no doubt we are facing very large fiscal deficits over the next two to three years."

And third, that Mr King's remarks have been seized on by opposition politicians. George Osborne, the shadow Chancellor, said: "This is a defining moment in the political argument on the recession ... The Governor of the Bank of England no less has said Britain cannot afford a further fiscal stimulus. He goes on to say that monetary policy should be the main tool to tackle the recession. This is hugely significant, as it vindicates the big decision taken by David Cameron and myself on the economy."

The Liberal Democrat Treasury spokesman, Vince Cable, said: "Any fiscal stimulus will have to be repaid in the future and so should encourage growth today as well as creating assets for the long term, neither of which the VAT cut has achieved. That is why the Liberal Democrats argue that the VAT cut should be replaced by a programme of targeted investment in affordable housing, large-scale home insulation and public transport improvements."

The former Labour Treasury minister, Stephen Byers, added to the Prime Minister's woes by claiming that the G20 summit agenda is too ambitious. He called for the withdrawal of the cut in VAT, the centerpiece of the Treasury's stimulus.

Mr King said that, apart from "targeted and selected measures" aimed by ministers at some sectors of the economy, the Bank is best placed to manage any boost to the economy through its policy of "quantitative easing", more colloquially called "printing money". Today the Bank will begin purchasing bonds issued by companies to help them raise capital more cheaply and to generally ease credit markets. Some £75bn will be spent in this way, mostly on government securities in the next three months. "We can do more monetary easing if necessary," Mr King added. The Governor said the policy's effects might begin to be judged in six months.

The Chief Secretary to the Treasury, Yvette Cooper, denied any rift between the Government and the Bank of England: "What [Mr King] said is we need to take a sensible approach, which we always do." Mr Brown's official spokesman merely added that the Bank "has supported the current action of fiscal stimulus".