Leading article: The economy still needs support from the state

The Bank of England is right to maintain its policy of quantitative easing

Are we witnessing an economic sunrise after a long, dark night? Some say so, pointing to signs of activity in the housing market, the ebullience of stock market investors and announcements of profits from some of our high street banks. Sadly, though, the light we are witnessing is artificial. This is no private sector-led recovery. What brightening there has been is almost entirely due to state intervention in the economy, from the taxpayer-funded recapitalisation of the banks, to monetary easing by the Bank of England and fiscal stimulus in the form of the VAT reduction.

But while the economy is stabilising after last autumn's heart attack, it remains a sickly patient. The latest results from Northern Rock and Lloyds shows banks are still on life support. Bad loans are piling up as businesses go bankrupt and homeowners default on their mortgage repayments. Barclays and HSBC have done better, but thanks only to their investment banking divisions, which have benefited from the unprecedented efforts of authorities on both sides of the Atlantic to pump money into the credit system. These injections of liquidity have helped the investment banks of Wall Street and the City of London, but the wider economy has seen much less benefit. Surveys by the Bank of England show that the supply of credit to small businesses and home buyers, even credit-worthy ones, remains restricted. The credit crunch is still with us; it has simply been better disguised since last autumn.

The signs of stabilisation in economic output have come, primarily, as a result of companies restocking after months of running down their inventories. Consumer demand for what they are producing is still extremely weak. The stock market rally ought to be treated with scepticism too. If corporate earnings prove disappointing when firms announce their results, or if there is another shock to the global financial system (a new banking crisis resulting from bad loans in Eastern Europe is a real danger), than we could easily experience a collapse in confidence and find ourselves exploring the second downward leg of a double-dip recession.

In this context, the Bank of England's decision yesterday to extend its quantitative easing programme is justified. For the Bank to have called an end to its purchases of Treasury securities would have felt to the economy in its present fragile state like a monetary tightening.

There is, of course, a danger of the authorities doing too much and stoking inflation through these efforts, but that risk has been overstated. The money supply is still growing only modestly, despite five months of gilt purchases by the Bank, and the pace at which money is circulating remains sluggish too. Recent figures have shown inflation dropping rapidly, not picking up.

There is every reason to believe that these deflationary pressures will continue. The gap between Britain's potential growth and the present level of output is still wide and unemployment is showing no signs of peaking. There is also little reason to expect wage rises to stoke inflation while employees seem to be accepting salary cuts as the price of keeping their jobs.

At present, the risks of the authorities doing too little to support the economy outweigh the risks of doing too much. Now is not the time to switch off those artificial lights.