Examination of Witnesses (Questions 60-79)
MR MERVYN
KING, MR
PAUL TUCKER,
MR CHARLES
BEAN AND
MS KATE
BARKER
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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