Examination of Witnesses (Questions 40-59)
25 MARCH 2004
MR MERVYN
KING, SIR
ANDREW LARGE,
MS RACHEL
LOMAX, MS
KATE BARKER
AND MS
MARIAN BELL
Q40 Norman Lamb: Are you all gradualists?
Could I ask Kate Barker?
Ms Barker: I am not sure that
I would necessarily describe myself as a gradualist but I certainly
do not subscribe to the view that surprises, not fully justified
in terms of what we think is going to happen to inflation and
the inflation target, would be the right way to proceed. You made
the point in your question that if you do start to proceed in
that way, there then start to be questions about credibility and
what you are actually trying to do with monetary policy. I think
the costs of going down that route therefore, in the long run,
are very considerable. In terms of what is happening to the consumer
at the moment, given the comments that have already been made
about debt, I think that jolting the consumer too much might be
a rather dangerous tactic.
Q41 Norman Lamb: This is a bit of balancing
act here?
Ms Barker: It is indeed. After
all, it is rather early to judge the full effect of the rises
in interest rates that have taken place. It is certainly the case
that one of the things that was on our minds, and the Governor
has already talked about it, when we made the first rise in November
was that because it was the first rise for some time, we might
get an unexpectedly big short-term reaction. We did not get that.
We certainly do not know at this stage what the full effect of
the rises that we have put in place is. My view is that the right
way to proceed is always to make changes in the interest rates
that are justified by our views about the inflation target. At
the moment, since we are not talking about a large overshoot of
the target, that is an argument for the small changes we have
made.
Ms Lomax: We have not seen the
need for large increases in interest rates. If you take an overview
of the pressures on inflation, the case for it is not made. You
can look at the balance of risk, but this is not just about controlling
consumer behaviour. This is about taking an overview of the inflationary
pressure across the whole of the economy. Perhaps the public debate
focuses excessively on consumer spending and the housing market
to the exclusion of other relevant considerations. That is the
first point I would add to what people have said here. The second
is on the question: is it right to surprise or not to surprise
the market. If we have an open and transparent framework for monetary
policy and we explain ourselves clearly and we are taking decisions
on the basis of information which is available to everybody else,
our actions should be pretty predictable. If we do things which
are going to surprise the market, we should have a very good,
clear reason for it. If you cannot answer the question "why
are you surprising people in the markets?" in a clear and
convincing way, then you should not do it. You are probably wrong.
Q42 Norman Lamb: Sir Andrew, you do take
something of a different view. You have talked specifically about
your concerns about household debt. You have done a whole speech
on it. You were described yesterday in The Financial Times
as the "Bank hawk". You have talked in your speech about
credible threats. I think that was the phrase that you used. You
have a greater concern here, do you not, and you have consistently
voted for rate increases. Why do you take that view?
Sir Andrew Large: Are you wanting
me to talk about gradualism or caution?
Q43 Norman Lamb: Yes.
Sir Andrew Large: I think you
used the words yourself that it is a matter of balance between
cause and effect. I think the other point that perhaps is worth
drawing out is that, as the Governor said, there may be some element
of distinction between surprise in relation to the direction of
rates and surprise in relation to the timing, and so I think it
is important to bear both things in mind.
Q44 Norman Lamb: While I am with you,
can I just put to you what the Chancellor said yesterday? He seemed
to take, some might say, an almost complacent view of the risks
that household debt could pose and did not seem to take any view
of the credible threat that you talked about. He talked about
debt servicing costs equalling 7%. I thought you were indicating
it was nearer 10%. He says, "This is a reflection of the
course of low interest rates but I do not think anyone, including
the Deputy Governor, is suggesting that we should be returning
to interest rates of the early Nineties". But you are saying
that if interest rates continue in their current trend, we will
get debt service costs similar to, if not equal to, those of the
early Nineties, are you not?
Sir Andrew Large: This is in relation
to the rates in the marketplace, and so in that sense if debt
levels rise also, as the Governor said, yes, that is the way that
the arithmetic goes.
Q45 Norman Lamb: So the Chancellor was
wrong in discounting that?
Sir Andrew Large: I do not think
the Chancellor was wrong. I think the Chancellor was referring
to the central case. I think he was also referring to figures
that are quite recent rather than looking ahead. That was my interpretation
of it.
Q46 Norman Lamb: At what point in interest
rates do we get to that point where the debt service levels are
similar to the early Nineties?
Sir Andrew Large: Depending on
the assumptions that go into it, you are looking at two to three
years ahead.
Q47 Norman Lamb: So that is the crunch
point, is it? That is the period that you would be most concerned
about?
Sir Andrew Large: Yes. Whether
it is precisely two or three years, it is difficult to say, but
perhaps I could just say this. Some people will describe others
by birds' names, et cetera, but these decisions are very much
a matter of balance and at the margin. The point that I have been
trying to make is that I do see a possible risk, not a strong
likelihood but a credible threat that, under those circumstances,
looking ahead, there could be a downwards move in demand as a
result of this that would make it difficult, or more difficult,
for us to continue meeting the target that we have. So that is
why, given that I see it as a credible threat, I take it into
account.
Q48 Chairman: Marian, would you like
to comment?
Ms Bell: I agree with a lot of
what has been said, but I would just like to emphasize that our
remit is to target inflation, not house prices, consumer debt
or any particular source of demand, such as the consumer, so in
our discussions the focus is very much on how these things would
feed into inflation. I would certainly agree with the point of
view that if you were to try and prick a bubble of any sort, the
sort of interest rate changes that might be required to do that
could do damage to the economy and lead to a failure to meet the
remit in the short run. With regard to gradualism, that is what
our forecast implies at the moment. We expect to under-shoot the
new target for most of the next two years. If we did not see the
kind of slow-down we are expecting, and if it looked as if we
needed to do more, more quickly, more aggressively, on interest
rates, then I am sure we would do that, and hopefully that would
be well expressed and understood by the markets.
Q49 Chairman: Rachel, you mentioned something
about household debt but, given your views about the growth of
household debt, why did you not join Sir Andrew in the past few
months in voting for increases in interest rates?
Ms Lomax: What views do you think
I hold about household debt? I think I made that clear in a speech
I gave in Bristol recently. I regard the build-up of debt as an
issue which is one of the balance of risks that we look at. We
do endlessly discuss some of the issues that we have been talking
about this morning.
Q50 Chairman: So you think it will take
quite a long time to get back to the level of household debt we
had in the Nineties? I am talking about the headlines that were
put to Sir Andrew's speech the other day. How long do you think
it will take us to get back to that, or do you not think we will
get back to that?
Ms Lomax: Andrew was talking about
the levels of debt service, I think, the proportion of income
that would be taken in servicing debts, assuming that the debt/income
ratio goes on rising. I would think that what the press say and
what Andrew said in his speech may be two separate things on one
or two issues. I have read the speech a couple of times so I know
what he was trying to say.
Q51 Chairman: It is important for the
market and the press to have an understanding of what the view
of the MPC is. It is with that in mind that I am trying to get
clarity at this point.
Ms Lomax: Yes, and I am very happy
to answer your questions. Can I go through it again? The point
that Andrew was making, which, as you said, we had made in the
minutes, and we have actually made in the inflation report a couple
of times, I think, is that if the debt/income ratio goes on rising
as borrowing catches up with the increase in the value of the
housing stock, as the Governor explained, and as we think is likely
to happen, and if interest rates rise in line with market expectations,
you will see a rise in the proportion of income which has to be
devoted to servicing and repaying debt. The question is, what
impact will that have on consumer spending and what else will
be going on in the economy at the same time, and through all that,
what impact will that have on inflation? There are a lot of imponderables
along the road to answering those questions, and I think the exercise
we go through when we do the inflation report and when we take
interest rate decisions is about weighing those risks at each
stage. I would not say that just because income gearing rises
over the next couple of years that it will necessarily cause problems
either on a central case or on a balance of risk analysis which
suggests we ought to be putting up interest rates now. But I do
think these are issues we need to reflect on and set against the
other risks that there are about, risks to do with the world economy,
what is happening with the exchange rate and all the rest of it.
This is not the only material source of risk at the moment.
Q52 Chairman: Sir Andrew, just to
finish this, if you had been writing the headline for the newspaper
yesterday, I gather you would not have written that.
Sir Andrew Large: I would not
have written that headline.
Q53 Chairman: What would your tabloid
headline have been on your speech? What would you have said? To
make it easy for the consumer, what would you have said, in half
a dozen words? I will give you time to think about it.
Sir Andrew Large: If you give
me a little while, I will try to think one up. I am not a great
headline writer.
Q54 Chairman: Before you leave, you
have to answer, Sir Andrew.
Mr King: Can I just make one point?
All this debate on debt is actually summarised at paragraph 14
of the Committee's March minutes. The key sentence, reading straight
from the March minutes, is "The income gearing implied by
current and prospective indebtedness, if interest rates followed
the trajectory implied by market forward rates, would reach levels
last seen in the early 1990s within two or three years. A key
difference, however, was that this increase could be anticipated,
as it was not the result of unexpected policy changes . . ."
Chairman: That is not a snazzy news headline,
is it?
Q55 Mr Walter: I wonder if we could
look for a moment at the international value of sterling. Sterling
seems to have recovered most of the weaknesses of last year, with
the trade-weighted index at around the 105 mark, which is roughly
its five-year average. The dollar has been particularly weak.
What do you attribute the current value of sterling to? Is it
your monetary policy or is it somebody else's monetary policy?
Mr King: I do not know. I do not
think it is either our or other people's monetary policy, because
we look quite carefully to see whether the changes in sterling
in recent months—the last two months is when it has picked
up again—occurred in the wake of changes in either actual
or expected interest rates as revealed by the market yield curve.
There is very little evidence that in fact the movements of sterling
can be attributed to movements in the yield curve, so that is
an explanation that we do not attach much weight to. In the March
minutes we did go through various possible explanations for the
rise in sterling, noting that sterling had risen against most
other currencies, that the recent pick-up was not against one
currency or another but against the generality of other currencies,
and I am afraid that we could not come up with any convincing
explanation, so I am afraid the answer is we do not know.
Q56 Mr Walter: That is a fair enough
answer. Can I move on to perhaps a more technical question, and
that is the composition of the basket for the trade-weighted index.
There has been quite a bit of comment recently suggesting that
this is out-dated and that it needs revision. Do you have any
views on that?
Mr King: This is not a new issue.
This has come up at regular intervals in the last ten years, I
believe, and we do internally look at a broader exchange rate
index as well as the narrow index. We would very much like to
be able to move on from where we are because in order to construct
the current effective exchange rate index, we use trade weights
for other currencies, which are given to us by the IMF because
they have the source of data for trade among countries, and it
is very important that we look not just at trade directly between
the UK and other countries, but at the impact of third party relationships,
trade between the dollar and euro area, in order to calculate
the true effective exchange rate index. This is not something
that trade data available to the UK authorities is sufficient
for. You do need a broader set of trade data, and their figures
are certainly very much out of date. We have been talking to the
IMF about whether it is possible for them to update their estimates,
and I hope we will see progress in that direction. To offset that,
we have, as I said, looked at our own index, both in the current
narrow form but also in a broader form, expanding the number of
countries to around 50. It is true that in the last couple of
years that exchange rate measure has risen more than the narrow
effective exchange rate index, and that is something that we can
take into account in coming to our judgments. It is not true that
that broader index is a better guide in the longer run, because
one of the reasons why it has moved around a good deal is to do
with the very sharp changes in currency values in emerging markets.
Sometimes they are so large that you can be confident—and
indeed, they have been followed by changes in inflation, so that
big movements in that kind of index do not signal changes in competitiveness,
because they are likely to be offset by inflationary consequences
of the exchange rate changes themselves. We would very much like
to find a way of updating the weight and expanding the coverage
of the present index to include services, more countries and so
on. We are thinking of ways of doing it. We do think it makes
sense to try to do this in conjunction with the IMF, we are certainly
working with them on that, and when we have something to produce
or announce, we will do that and we will let you know.
Q57 Mr Walter: In your February inflation
report you said you were looking for a solid recovery in export
growth in the near term. However, in the annexe to the March MPC
minutes in the data that you use, you refer to the fact that total
exports had risen in the fourth quarter by 1.8% whereas total
imports had risen by 2.2% and then even adjusting for the effects
of missing trader intra-community (MTIC) VAT fraud, export and
import growth had been estimated at 1.95 and 2.4% respectively,
so the proportions are roughly the same. Has the recent data on
the trade deficit changed your views on export growth?
Mr King: No, because I would not
want to put very much weight on any single statistic, and certainly
not in the trade area. They have been very volatile from quarter
to quarter, they are often volatile from one half of the year
to the next half of the year. And there have been major statistical
problems to do with the recording of both exports and imports.
We hope we are coming to the end of that, but I am far from confident
that we have got to the end of that period of difficulty. I would
not want to put a strong judgment just on the latest statistics—certainly
not—and I am very unconfident on what the outlook is for
the trade position. All I would do is refer back to what I said
earlier, which is that the business surveys themselves appear
much more buoyant about export prospects than they have really
since the mid 1990s. It is quite a noticeable change. Whether
that will feed through given the recent rise in the exchange rate
remains to be seen. It is something we will watch carefully. It
is extremely hard to measure these data accurately, and we have
seen specific problems to do, as you have mentioned, with VAT
fraud, but there is also the new method of recording statistics
in Customs and Excise. Both of these have given quite different
problems to the analysis of the trade data, and all that comes
on top of the usual volatility. So I think it will be some time
before we can be confident of how that picture is evolving. You
talked earlier about the trade deficit and how it will move. We
have seen very significant revisions a year or two down the road
to the figures for trade and services, so again, one cannot be
confident of what these data really mean at this stage.
Q58 Mr Walter: The recent trade data
have indicated that the depreciation of the dollar is causing
some difficulty. Your regional agents indicated that exports to
the US were only profitable below an exchange rate of $1.60-1.70.
Does that cause you any concern?
Mr King: Some say that. I do think
that, compared with where we were a couple of years ago, the balance
of exchange rates is one that people find much more acceptable
than was the case before. Obviously, individuals who focus entirely
on the dollar market or the euro area market will have views relating
solely to the bilateral exchange rate, but there is no doubt that
we were at an exchange rate against the euro that it was difficult
to believe was likely to prove sustainable, and it has not proved
sustainable: the exchange rate against the euro has come down
quite significantly compared with where we were. Against the dollar,
clearly, we have gone up. But in part that reflects the fact that
the US economy has a very large current account deficit. For many
years economists have been saying that the dollar would fall and
it did not. But in the end it did, and it has fallen quite significantly
over the past two years. Its effective exchange rate index is
now 12% down, despite the recent recovery. Who knows where it
will go in the future? However, I think this change in exchange
rates has given us a better balance within the overall effective
exchange rate index.
Q59 Mr Walter: I want to move on
and make a comparison. You have just mentioned the US current
account deficit, which is causing a problem, and the US current
account deficit of course is generally financed so long as foreign
investors are prepared to buy dollars, particularly Asian central
banks. We have been running a current account deficit since 1982,
and it is becoming almost structural. Does that give you any concern,
and do you believe that we also have the ability, like the United
States, to finance that virtually ad infinitum?
Mr King: I think there is a big
difference in the scale of the current account deficits between
the US and the UK. That, I think, is very relevant to the question
of whether one can continue to finance it, because the scale of
the US deficit was financed initially by large inward direct investment
and inward portfolio equity investment, and there has been a change
in the nature of their financing flows; it is much more short-term
now, increasing short-term dollar-denominated assets, and obviously
particularly increased holdings by Asian central banks. It is
not obvious that that will go on indefinitely, so I think there
is a much stronger case for supposing that there will be a change
in the financial flows to the United States than in our case.
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