Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 40-47)

8 JUNE 2004

MR ROGER BOOTLE, PROFESSOR DAVID MILES AND MR DAVID WALTON

  Q40 Mr Walter: I wonder if we could look at sterling and perhaps direct this question to Roger Bootle because you told us back in November that the risk of gradual increases in interest rates was that it would put sustained upward pressure on sterling. To what extent do you think recent sterling appreciation has been as a result of those increases in interest rates?

  Mr Bootle: That is very difficult to know as one cannot quite tell what the position would have been without this policy. I think it has been an added major factor in the sense that operators in the markets have been faced with a level of sterling interest rates which has been very high by international standards—1% in the US, 2% in the eurozone and 0% in Japan—and, what is more, a pretty confident view that that level was going to increase over the next year or 18 months or so, which I think is a pretty encouraging background for the currency, other things being equal. The counter-approach I suggested which I think might have the added benefit of easing pressure on sterling was to get the policy of rate rises over as quickly as you possibly could, and this chimes in with the idea of the shock, which I think would produce a lower peak as well, but would foreshorten in financial operators' minds that period of rising rates during which I think they naturally would be buyers of sterling.

  Q41 Mr Walter: Do you think that the fact that people now expect the Fed to increase rates in the US and that the European Central Bank is probably not going to have any more rate cuts for the time being will take the pressure off?

  Mr Bootle: To some extent, but I think all the indications are that the rise in interest rates is going to be pretty slow, and, after all, from this very low level rates are going to be at the lower sterling rates for as far as the eye can see and meanwhile in the eurozone I guess similar points apply and, if anything, it is not obvious as and when euro rates will go up and I still think they might even come down, so I do not think there is a great deal of room for confidence on that score, that the pound is back.

  Q42 Mr Walter: I wonder if we could go on to look at the trade situation. The MPC expects a solid recovery in export growth in the near term. Now, this is in the face of what is an enormous trade deficit which we are facing at the moment, sterling is currently pretty strong against the dollar and Asian currencies and we have continued weakness in the eurozone, in domestic demand there, so do you think there is a risk that we are not going to get that solid recovery in export growth and in fact UK exporters are going to be squeezed out of those markets?

  Mr Bootle: Broadly speaking, I would concur with the Bank's judgment. It does look as though the UK's export markets are going to be growing pretty reasonably. If you weight the projected recovery in world growth by the UK's exposure to different markets, I think you ought to expect a reasonable recovery in UK exports. The big source of anxiety is the one you referred to, namely the fact that well over half of our goods exports, goods, not services, go to the eurozone and that of course at the moment is not doing very well. If the eurozone were to stage a decent recovery, in this context of overall world recovery, then I would be pretty confident that UK exports would pick up quite strongly.

  Q43 Mr Walter: What about the comment which is in the February Inflation Report from the Bank's regional agents that trade with the United States is only profitable with an exchange rate between 1.60 and 1.70?

  Mr Bootle: Well, it would not be entirely surprising. I think that the movement of the exchange rate has done some significant damage and what we know about movements of exchange rates is that the effects do not come through very soon and the lags are quite long. If you go through a long period of high exchange rate, you may first of all think that it is perfectly okay and only subsequently do you find that it is not when people are forced out of business or decide not to move into a particular market because they find there is no money in it.

  Mr Walton: It is also the case that business surveys, both the CBI and the Purchasing Managers' Index, their export components are at eight-year highs, so it does suggest at least at the moment that companies think that conditions are really quite good for them and it is a bit of a puzzle why the Office for National Statistics actually showed a more than 5% decline in non-oil export volumes in the first quarter, so if there is a discrepancy anywhere, it is there, I think.

  Q44 Mr Walter: Do you point to any reasons why? There is always optimism, yet the figures seem to be showing a contrary picture.

  Mr Walton: Well, I think the figures are probably wrong, is the most simple answer.

  Q45 Mr Walter: Can I move on and just look at another technical aspect, and I am not sure who might want to answer this. This is the criticism which has been expressed with regard to the Bank of England's operations in the sterling money markets and the volatility in those markets. I know that the Bank is currently undertaking a review of its operations in the markets, but there does seem to be a significant volatility in the overnight rates, some in the region of 200 basis points. I do not know who has a view on this, but do any of you think that the Bank is not fine-tuning the markets in the way in which other central banks do and do you think there is scope here for improvement?

  Mr Walton: I do not really have a view. Clearly you do not particularly want volatility and I think the Bank is, therefore, right to be looking at ways in which it can improve its money market operations, but I do not really know enough of the specifics to have a very good view.

  Chairman: Would any of you?

  Q46 Mr Walter: Perhaps we should ask the Governor when he comes.

  Professor Miles: Volatility in the overnight rates, it is hard to see that has any advantages at all and if the Bank, in changing its operations, can reduce that, I think that is something they will self-evidently want to do. It is going to be hard to find anybody who would be against that. I think Paul Tucker on the MPC has been taking the lead in undertaking some research on how changes might be made to volatility.

  Mr Walter: The problem is that it tends to be the corporate borrowers who suffer from this because other market operators are anticipating the moves.

  Q47 Chairman: Finally, in your paper, David Walton, Goldman Sachs—Where Has The Money Gone of 12 December 2003, your estimate of the output gap is around one half of that of the Treasury's, suggesting that there is less room for nominal inflationary growth. How do you interpret the analysis in the Inflation Report of measuring the impact of government spending on inflationary pressure and do you think this analysis lies behind the MPC's pessimistic assessment of the amount of spare capacity in the economy?

  Mr Walton: Well, I actually think the MPC approach is a very sensible one because actually we do not know precisely the split between real output and inflation, but we do know the nominal amount of spending that is going on and that is ultimately what is putting the pressure on resources. If, as a result of this review of public sector output, we find that productivity growth has been stronger in the public sector and that we have got more real output, then real GDP will be higher, but it does not mean to say that there is any less or any more slack in the economy. I think this approach of looking at, "Well, this is what overall spending is and this is how it is impacting all parts of the economy", that, in principle, is probably a more fruitful approach than trying to be too specific about the split between prices and output.

  Chairman: Well, can I thank you for your attendance this morning; it has been very helpful to us and we only had an hour, but I think we got across all the points which we wanted to, so thank you very much.





 
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