Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 60-79)


29 JUNE 2006

  Q60  Peter Viggers: Would you please comment on the state of the housing market? I ask that because in the May Inflation Report there was mention of a revival in the housing market; in the MPC meeting on 7/8 June there was talk of mixed reports from the housing market, so what is your comment, in view of this?

  Mr King: The big picture in the housing market, which I think is still true, is that we saw, as you will recall, two years ago, very rapid increases in house prices. The rate of house-price inflation was running at between 25% and 30% a year. Interest rates were raised several times to meet the inflation target. As domestic demand itself started to slow, following the increase in interest rates to meet the inflation target, the rate of house-price inflation fell back very sharply and the rate of activity in the housing market also fell pretty sharply for a period of about six months. Since then we have been in a position in which house prices have been moving up slightly, but not particularly dramatically, and activity in the housing market has recovered and is running certainly at least its normal minimum level. So the housing market is much more back to normal. There are differences between different parts of the country and I think there is no doubt that one should always bear in mind that a city like London is an international housing market and one should not expect what happens there necessarily to reflect what is happening in the UK economy as a whole. By and large, the housing market has been in a reasonably stable position, but there are still questions that you could ask. The level of house prices still seems rather high relative to all the traditional indicators that people use to judge the level of house prices, whether it is earnings, incomes, and so on. There have been changes, we are living in a different world now, of lower and stable interest rates. In that world people may well be willing indefinitely to pay higher prices for housing indefinitely. I think we find it very, very hard to judge how sustainable all of this is, but so far we have been in a pretty stable position, and long may that continue.

  Q61  Peter Viggers: The loans-to-income ratio is rather high, it has edged up, whereas the percentage of income spent on a mortgage by interest mortgage repayments actually has gone down in the last year.

  Mr King: I think this goes back to what I have just said. There are two things you could say. One is that the ratios of assets and total liabilities to income have both gone up a great deal, so the size of the balance-sheet has expanded. If you look at the traditional measures of vulnerability of households, in particular, how many households have very high mortgages relative to the current value of the house, those sorts of numbers actually are very much lower than they were in the early 1990s. Take the number of repossessions, for example; that is very much lower than it was when they peaked in the early 1990s. Those sorts of vulnerabilities, those measures of pressures in the housing market are not showing up at all in the current statistics, but there is no doubt that, as in other countries, we are in a position where many sectors now have a much greater size of balance-sheet relative to their income flows than we have seen for a long time.

  Q62  Peter Viggers: Professor Sheila Dow, in the May Inflation Report, warns that whilst borrowing is secured this depends upon the availability of selling, should it become necessary, and points out that this could lead to some macroeconomic results if there should be a spiral of sales?

  Mr King: It is always the case that when you have such elevated balance-sheets there is a risk that the value of the assets falls and the liabilities do not fall. Of course, anyone who borrows for a house knows that the value of the mortgage is not dependent upon the value of the house, they can move independently. If you look at the overall balance-sheet and look at the position of households with secured borrowing, there do not seem to be signs of great vulnerability there. It would require a very, very substantial change in house prices to go back to the situation we saw in the early 1990s and that does not appear to be likely at present. I do not pretend to know the future or to give any guarantees here, I am in no position to do that, but as things stand we have seen a much more stable housing market, and if there are adjustments to be made obviously we would prefer them to be made slowly and gradually over a long period. We will see whether that takes place.

  Q63  Mr Newmark: In discussing balance-sheets, if we believe what is true out there, people's personal circumstances seem to be getting worse and worse, if you look at just the debt side, not the asset side, i.e. there is this figure of a trillion pounds that is bandied about of consumer debt which is out there. In your comments on the May Inflation Report you said that a quite large social problem of insolvency and problem debt is materialising but also downplayed the macroeconomic impact of this problem. I am just curious, how much insolvency would it need before you deemed this problem to have a macro effect?

  Mr King: Perhaps we will have to define what we mean by `macro effect' but I would mean a significant impact on the total level of consumer spending. The number of insolvencies has been rising quite sharply; last year it was 80,000. I think that is quite high but it is less than 0.2% of the adult population; that is unlikely, therefore, to have a significant impact on the total level of consumer spending. Even if you try to ask a broader question, which is do not look at the number of people going into insolvency in one year but, at any given point, how many people have a credit track record, a credit score, on which is marked some sort of experience of insolvency or bankruptcy which would affect their ability to borrow and possibly spend, if you project the current high rates forward, it is conceivable that you might get to a point where, at some day, one in 100 people would have a credit record where this was marked. I find that surprisingly high, as a description of the number of people who get into financial distress, but I do not think I can argue to you that, since most of this is coming from unsecured borrowing and the amounts are not large relative to average incomes but they are to the incomes of people in trouble, this is likely to be a major determinant of consumer spending. Indeed, we have seen in the United States that these numbers can be much, much higher than here and yet have no impact on what is a very rapid path of consumer spending. I do not think this is a major issue for the total path of consumer spending and most of the issues in terms of debt, problems of debt, are coming from unsecured debt. Most debt taken out by householders is secured debt, there does not seem to be major vulnerability there, if there is no dramatic move in house prices. There are problems with unsecured debt.

  Q64  Mr Newmark: I want just to pick up on something you said on your May Report. You said: "The flow of insolvencies in the first quarter is equivalent to one-fifth of 1% of the adult population getting into trouble . . . " and that is an annualised rate. To me, that would seem a red flag, notwithstanding the rates they have been on in the US, and I want to get onto that in a minute; are you saying that is not really a cause of concern to you?

  Mr King: No. Let us not use words like `concern', let me try to talk about the impact on numbers. The number of people who went into insolvency last year and the rate in the first quarter of this year is 0.2% of the adult population. Since the insolvency arrangements now mean that people come out of insolvency after a year, there is not that much difference between that figure and the total stock.

  Q65  Mr Newmark: The trend itself does not look good, or does it, you tell me? I am just taking what you have said here, that is all I am doing.

  Mr King: I am taking the 0.2% figure as well and I am trying to explain to you why a 0.2% figure, to me, does seem to be large relative to what I would expect to be the number of people getting into serious financial difficulty. I am not going to pretend to you that 0.2% of the adult population who get into trouble with unsecured debt is likely to have a major impact on the path of total, aggregate consumer spending in the economy. I am not making any judgments about it. I am saying that just as a description of the facts.

  Q66  Mr Newmark: You have pointed to the higher level of personal insolvencies in the US as sort of a benchmark to say that, insolvencies, what is going on in the UK potentially is sustainable. Has the Bank done any sort of cost-crunching analysis to compare the different systems and to ascertain the effects, and are we undergoing a cultural shift to creating behaviour with our consumers similar to the US?

  Mr King: I do not think there is any evidence to suggest that we are going to go to the same levels as the United States. I think it is difficult to compare them. One of the facts which is relevant here and goes to the heart of your question is that most of the rise in the number of insolvencies appears to have been initiated not by creditors but by the debtors themselves. In other words, householders are saying "I have got into trouble, I need to do something to sort out my own financial affairs and therefore I will engage in either a bankruptcy or voluntary arrangement in order to sort out my affairs." These are being initiated by debtors.

  Q67  Mr Newmark: There is a knock-on effect to that; it creates a cultural shock. If people can go into bankruptcy more easily, which it seems, and then get out of their personal problems a lot quicker, which seems to be the trend, again, there has to be a knock-on effect into the way you are thinking in the macroeconomic impact again, or not?

  Mr King: It depends how big it is. In principle, if it is big enough, yes; but 0.2% probably not. My point was that since it is being initiated by debtors it does reflect a change of attitude on the part of borrowers. I am afraid that economics is not a science that can tell you how to predict changes in attitude, and there may well have been a cultural change.

  Q68  Mr Newmark: If the levels are changing, there is a cultural shift. If people are able to borrow more, which it seems, decide that they can go into bankruptcy more, in fact, they are going into bankruptcy more, and then get out of it at the other end much more quickly, to me that signals a cultural shift?

  Mr King: A cultural shift in what respect? After all, we have tried quite consciously to make it easier, in many ways, for companies to sort out their financial problems so that they can then return to successful operation.

  Q69  Mr Newmark: Sort of a Chapter 11 system?

  Mr King: Yes, and I think that it is a very far cry to move from describing what is happening in the economy now to judge from that people are borrowing deliberately, knowing that they can get rid of those debts. I think there is no evidence at all that the people who get into these difficulties and go bankrupt and take out voluntary arrangements are saying to themselves "Well this isn't too bad, we can get rid of the debt." It is a pretty painful experience, and, as I said, it remains on their credit rating for six years. That is why I gave you the other number, which is that if the flow carries on at its current rate then it is conceivable that over a period of time we might get to a point when the total stock of the number of people with a credit score linked to a past involuntary arrangement, or bankruptcy, could reach one in 100. But we should remember who they are and the size of the debts that we know are relevant to these arrangements, which are relatively small compared with average incomes and assets in the economy. To be clear, these are not wealthy people. Often these are poor people who have taken out big credit card bills, a store card, high interest rates—you have reported on this—it builds up and the numbers become large for them. At this stage, I do not think I would want to pretend to you that this is the major issue facing the Committee in judging the path of consumer spending.

  Q70  Mr Newmark: John Butler, in his submission to us, describes the rise in personal insolvencies at a time of low levels of unemployment as a `puzzle', that more people are going into insolvency but unemployment is fairly low. What indication do you think the rise in insolvencies provides as to the current interest rate sensitivity of households?

  Mr King: I think that is a quantitative issue and I think the same argument would apply, that if this is not having a major impact on the total path of consumer spending then I do not think it is a major issue in terms of interest sensitivity. I think what clearly is the case is that, for households on average, all the household sector, if you asked the question "What is the impact of a 25 basis point change in interest rates?" the percentage increase in debt repayments is much higher than if interest rates were starting at 10%. That certainly is something that we take into account and are conscious of when making our judgments. It may well be that we are in a world now where, for many reasons, the magnitude of interest rate movements is likely to be less than often has been the case in the past. This is not just to do with issues of debt or household finances; there is a much broader set of issues which will determine by how much interest rates have to move.

  Chairman: After that exchange, Governor, there is a chance maybe that some of us will waken up screaming during the night "0.2%," so I think we had better warn our families. I think you have worked through that nicely for us.

  Q71  Mr Fallon: Governor, just returning to your concern over the timeliness of the appointment process, would you share my view that it might be helpful for those involved in this to set some kind of benchmark target, it might not be met in all circumstances, that these replacements normally should be announced, say, within a month, or two months?

  Mr King: We have a fixed timetable for the terms, so in most cases, though not all, we know when people are likely to leave and when their replacement is needed. I do think it would be helpful to have a presumptive timetable and, yes, I think there is a lot to be said for that. I remember, last October, that I had a long conversation with the Chancellor then about the nature of the replacement for Steve Nickell and he readily agreed that we were looking for a good academic. It was unfortunate, in a way, that there was some press comment and letters to the newspapers about what kind of person; that decision had been taken back in October. I think that some presumptive timetable and some means of making it just a little bit more systematic probably would be helpful.

  Q72  Mr Fallon: Returning to the risk to the forecast, John Butler, our adviser, from the HSBC, identified the key aspect of your May Report as expecting inflation to overshoot the 2% target if you kept rates constant; in other words, he assumed a bias towards tightening. What I am unclear about still, and from your statement this morning, is really what has changed between November and May to make people make that assumption, given that wage growth has been muted and some of these energy costs seem to be being absorbed. What has changed really?

  Mr King: What changed, rather than "has changed" because things have changed again between May and now. Between November and May we had seen revisions to the data and we had seen a confirmation of the recovery in the second half of last year and the first half of this. Back in November we were looking at a period where all we saw really were hard data showing the sharp slow-down in the first half of last year, some anecdotal reports from Agents and others to suggest that the economy had picked up a bit in the second half, although the reports from retailers for the early autumn last year were very depressed and there was a lot of uncertainty about that. By the time we got to May we knew that at least the first estimates, and I think these were confirmed by our own Agents' reports. Our own impressions, going out into the regions, were that by the last quarter of last year and the first quarter of this output growth basically was back to trend, and that was a change, I think.

  Q73  Mr Fallon: The data since May, do they fail to confirm the bias towards tightening and indicate that perhaps rates need not rise as much as interest commentators are expecting?

  Mr King: The phrase "bias towards tightening" is your phrase. We do not use phrases like that. The word "bias" has been used by many central banks to mean quite different things. What we try to do is just publish our projection and let people draw their own conclusions. The projection in May, as you describe it, was indeed that if interest rates were to remain constant then inflation would be above the target looking two years, or so, ahead. Markets draw their conclusions, and indeed they had not been expecting rates to be completely constant even before they saw our Inflation Report. Since May we have seen not a lot of news but we have seen some quite sharp movements in asset prices. Share prices have fallen, they are 6½% down on the level that we used in making that projection in May. The exchange rate effective at present 1½% of sterling is, above the level that was used in that forecast. We will have to look at this and come back to it again in our August forecast. We do not try to pretend to tell you where interest rates are going; what we tell you is what our analysis is of the economy. What I would say is that I do not think the picture has changed greatly since May, we have had these changes in asset prices but we have not seen a very substantial amount of news.

  Q74  Mr Fallon: The changes that there have been since May have not increased the uncertainty?

  Mr King: Except in one respect, which is that the volatility of asset prices and prices in financial markets has increased the amount of uncertainty. Indeed I would say that since January, we have seen quite a significant rise in long-term real interest rates around the world. In some sense, the surprising fall in long-term real interest rates that we saw in the second half of last year, in all the major developed countries, has unwound in the first half of this—they have gone up by 50 basis points. Some of the puzzle about why long-term real interest rates were so low has gone away, but not all of it.

  Q75  Mr Love: Can I press you just a little further on this. I take your point that you produce your Report and let others interpret it, but it has been interpreted widely as showing a bias towards tightening. I think generally that is accepted, certainly it was commented on in the media. As well as the factors that Michael has just mentioned, about non-energy inflation has come down, the labour market has listened, sterling, as you have already indicated, has appreciated, which should help the inflation situation, what is your thinking, in the Bank, in relation to why you are tightening at this present time?

  Mr King: We are not tightening interest rates.

  Q76  Mr Love: No, I understand that, but why is there a bias towards tightening?

  Mr King: There is not, as I said. These are not our words. I am surprised that you believe everything that you read in the newspapers. I think you should make your own judgment. What I have said is that what has changed over the last year really are two things. One is that economic activity in the UK has strengthened quite considerably. Despite the caution that many people felt, and certainly the Committee felt, about how quickly consumer spending would recover, it does seem to have recovered, and the figures that we have seen for growth in the last quarter of last year and the first quarter of this year are pretty much close to trend for economic growth. The second quarter certainly looks as strong. It seems now that we can conclude that the slow-down at the beginning of last year was relatively short-lived and not particularly serious. That is something we know now that we did not know last year and I think basically that is why there is a change in the climate. As I say, however, there is some uncertainty, and if you look at the Minutes for the last two or three months the uncertainty, the fall in share prices and the rise in the exchange rate, were factors which made the Committee decide to vote for no change, despite the conclusions which financial markets drew about the implications of our May Report for what might happen to interest rates over the next 12 to 18 months. We are making no judgment about that now. We will do it each month and then we will publish our minutes. If you look at our minutes you will see, I think, these two things, on the one hand, stronger economy, and on the other hand, clear signs that asset prices are falling, which will have an impact on domestic demand, and the uncertainty of financial markets, which has raised some question-marks about the path ahead. Those things have led the Committee so far to leave interest rates unchanged.

  Q77  Mr Love: I hate to use the media again, after your strictures on me, but the Bank for International Settlement's Annual Report came out last week and it seemed to be or certainly it has been interpreted in the media as suggesting that central bankers have kept interest rates too low for too long. Has that had any impact on your thinking?

  Mr King: I was in Basel last weekend, talking to the authors of that report. I will let them comment on what they feel about interest rates elsewhere. They have not said that about the United Kingdom, and indeed, of course, we were not one of the countries which cut interest rates to extremely low levels. That was very obvious in the United States, the euro area and Japan, but there are good reasons for that difference; those reasons did not apply to the UK. I think what was more interesting about the BIS report was its discussion, not the first time they have discussed it, though I think this was, in some ways, the most subtle discussion they had, about the fact that, looking ahead, there can be, as a result of these imbalances in the economy, the potential for a bumpy road ahead. They have been talking about that, not just me. Therefore, they have said, "Well, it may be necessary at times to set interest rates by looking ahead more than two years, not just the conventional two-year horizon, and to take account of the fact that if you really believe there could be some major either excess or shortfall of inflation below target, three, four, five years ahead, because of the imbalances that have built up in an economy, therefore you should take note of that now and do what you can to prevent a disorderly unwinding of those imbalances." That is something which both Charlie Bean and I have talked about, in speeches, several times over the past five or six years. I have no difficulty with this BIS proposition. I do not think it is about the framework for setting interest rates, it is an issue about what is actually happening in the economy. The reason why I think they have repeated this concern, and why perhaps it is more interesting now, is that in the past when they have said it people could agree on the abstract proposition but the real question has always been—irrespective of whether you were an inflation targeter or a money targeter, or as in some countries, have no clear framework what is going on in the economy, could there be a real risk? If there are people out there who take the view that as long as inflation stays steadily just at 2% a year nothing can go seriously wrong with the economy, I think they are wrong. There are plenty of things that can happen to an economy, in terms of adjustments to savings and investment, big swings in spending and output growth and employment, that can occur even if inflation is stable. So stable inflation is a necessary condition but it is not sufficient to prevent there being potentially quite big movements in the real economy. I do not think that there is anything that a central bank can do easily about that. If we really believed that there was an imbalance or movement in asset prices, which we felt we could offset by a movement of interest rates which we could calculate, which would prevent a major disruption down the road, then we would do it. That would be completely consistent with the inflation target because our task is to meet that over time, and if we could minimise the deviation of inflation from target several years ahead by taking some action today then certainly we would contemplate that. The difficulty is that every time anyone has ever raised this it has been far from obvious as to even the direction of what we should do, let alone the magnitude of the change in interest rates. Even now, are we supposed to be raising interest rates to slow down some of the expansion of balance-sheets or are we supposed to be cutting them because the exchange rate has gone up; it is very difficult to know actually what is meant here. Certainly I think the BIS is right to draw everyone's attention to the fact, even if we are successful at keeping inflation at 2% a year around the world, that will lead to a much more stable world than we would have had otherwise, but it does not guarantee that at all times there will be stability of output growth and employment.

  Q78  Mr Love: Can I look at the individual components of GDP. You mentioned earlier that you are moderately reassured that GDP growth is back on trend; you mentioned also in your statement that import prices have picked up. What is your major concern, where are the risks to the continuation of that GDP recovery?

  Mr King: As you said, GDP as a whole was, at the end of last year and the first part of this growing at a fairly steady rate close to its long-run average. We would expect to see, I think, some switch in the composition of spending which accounts for that growth in the economy. We would expect to see consumer spending growing much more slowly than it did in the period of the late nineties and early 2000. It has recovered from its slow-down last year, but it is not going to go back to the rates that we saw in the late nineties, early 2000, and, of course, public spending growth also is unlikely to continue at the very rapid rates we have seen in the last three years. Looking further ahead, we would expect to see some pick-up in business investment and some switch-around in the contribution of net trade to upward growth. I think the big risk is that, again, the slow-down in one does not coincide at exactly the same point as the pick-up in the other. The business surveys do suggest that the outlook for investment is more positive than for a while, and the data for the first quarter were also more positive. But these data are very volatile and subject to significant revision so three years from now the picture may look quite different from the one we have seen up until now. Exports; again the surveys are much more positive than for a while. I think the combination of the more optimistic surveys on exports still solid growth in the world economy, and slower growth of domestic demand which will, I hope, slow the growth rate of imports, and suggests that the outlook for the contribution of net trade to output growth is brighter than it has been for some time.

  Q79  Mr Love: I am slightly surprised at you saying that because there does seem to be some pessimism about the contribution that net trade can make to the economy. Are you sure that will make up for the changes in other areas, business investment? I am sure others will come on to business investment but, sticking to net trade, is that really going to make a contribution?

  Mr King: It has been so negative in recent years that even if it came back to merely a neutral contribution that would have an impact in offsetting a slow growth rate of consumer spending. I do not think we are looking for a dramatic change at all, we are looking for some rebalancing within the UK economy. Nothing dramatic but some rebalancing. All I am saying is that when we sat down and made our judgment in May we felt there were grounds for thinking that there would be some relative improvement, compared with the past, for net exports and business investment to help offset slightly slower consumer spending growth. Consumer spending has picked up we think to probably a little bit below its past historical average growth rate. That is to be expected, allowing for some head-winds from the size of balance-sheets, and so on. But we would expect to see, from the rest of the economy, enough spending to ensure the economy would just continue at its trend rate, not above it but at its trend rate.

  Mr Bean: Can I add, in regard to the contribution from net trade, it is a salient point that the euro area has been starting to pick up speed after a long period of very subdued growth, and given that roughly half our exports go to the euro area that is a particularly significant development in terms of potentially boosting net trade going forward.

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