Examination of Witnesses (Questions 20
- 39)
THURSDAY 24 NOVEMBER 2005
MR MERVYN
KING, SIR
ANDREW LARGE,
MS RACHEL
LOMAX, MR
DAVID WALTON
AND MS
KATE BARKER
Q20 Damian Green: Final question
for David Walton. The growth forecast of the Committee is now
higher than the consensus and you said in your appointment questionnaire
in October that there was a downside risk in the Committee's August
GDP forecast. Do you still think the risk is mostly on the downside?
Mr Walton: It was certainly the
case in August that there was some downside risk and I think that
has actually been reflected in the November forecast. If you look
at the profile that we have published for growth, the central
projection does have weaker growth over the next two or three
quarters; it takes a bit longer for the economy to get back to
a trend growth rate. I am quite content with the central projection
which is in the November Inflation Report. There are risks;
risks both to the upside and to the downside. There is a lot of
uncertainty about the future path of oil prices, there is a lot
of uncertainty about the world economy and there is a lot of uncertainty
about how households and businesses are going to react over the
next year. The fact that we have found it a bit difficult to explain
the past, always makes one a bit hesitant about predicting the
future, but that is what we have to do. The key thing is to judge
the data month by month with reference to our projections and
if, as the Governor said in his opening statement, the risks seem
to be materialising in one direction or another, then that gives
us prima-facie evidence that maybe some consideration of
a change of policy will be necessary.
Q21 Ms Keeble: I want to ask some
questions about household debt and interest rates. Richard Lambert
expressed concern last month that the MPC may have underestimated
the impact of earlier rate increases on highly indebted households.
Do you share that view?
Mr King: Certainly we might, it
is a risk and we state that clearly in the report. I do not think
it is the central view. The central view is the one that we factor
into our projections. It is important to distinguish between secured
debt and unsecured debt. Secured debt is actually 83% of total
debt; the vast bulk of the total household debt is secured debt
in the form of mortgages. Arrears on mortgages have picked up
very slightly, but they are still at the lowest level for a generation.
There is really no sign that, on secured debt as a whole, there
are any major difficulties for either borrowers or lenders. If
you look at the ratio for new buyers of houses, the loan to value
ratios, those are well below the levels which they reached in
the late 1980s, early 1990s, when many people were borrowing as
much as the entire value of the house when they bought it. That
is really no longer the case. So as far as secured debt is concerned,
it is not easy for us to think that this is a major concern and
of course there have been no big surprises. There have been no
big unexpected movements in either interest rates or incomes or
employment. In terms of unsecured debt, the story is rather different.
It is still the case that the bulk of unsecured debt is held by
households which are reasonably affluent, which repay their personal
loans or their credit card debt, but a minority of households—we
have pointed to this for some considerable time now and made this
point before to this Committee—has borrowed extraordinarily
large sums relative to their incomes and expenditure. This is
in the area of credit cards and store cards. They may have multiple
credit cards and they do face very serious problems now in trying
to work out how to consolidate that debt and meet their obligations.
I think that is more of a social problem than a macroeconomic
problem. I do not diminish its seriousness and for the individuals
concerned it can be devastating to find themselves in a position
where maybe personal bankruptcy is the only option when they suddenly
face up to this problem which has crystallised and that has repercussions
for many years. It is very serious for those individuals, but
I think our judgment is that it is probably not large enough and
the amounts that they have borrowed and spent are not big enough
for them to be a significant impact on the economy as a whole.
Q22 Ms Keeble: May I just come back
to the point of the problems in secured debt? If we look at first-time
buyers, we perhaps have to bracket that slightly differently because
of what has happened about house prices and who is actually getting
onto the housing ladder, so let us just look at existing mortgages.
Although the repossession levels are still low, I believe the
arrears levels have increased quite significantly and I should
expect that the fear would be that that would creep over into
rising repossessions which do become extremely problematic. Could
you say a bit more about that? I should question whether you are
perhaps being a bit complacent about what could be a growing problem
in the area of secured debt?
Mr King: Given that we start from
a position when arrears are at a remarkably low level compared
with historical experience, it would not be surprising if there
were some pickup in that figure, but I do not think it has been
really significant, certainly not on a macroeconomic scale. There
has been a more noticeable pickup from possession orders; not
in possessions, but possession orders. In part that must reflect
the change in the legal position that was made in the beginning
of last year, following the Enterprise Act in 2002, which means
that the lenders—if they are going to possess a house of
anyone who got into difficulties before 2004—have to take
action now because there is a statute of limitations which runs
out in 2007. That means that many of the lenders have said that
they have no intention of possessing, but if they are to retain
the option, they had better start taking some action and an effort
is made to consolidate people's debt and to look at it. I do not
think that it would be sensible at this stage to say that it has
reached the point where it is a remotely significant macroeconomic
issue. That is the concern of the MPC. I do not want to belittle
the problems of individuals in that situation, they are serious,
but they are not ones which are the responsibility of the MPC.
Ours is to look at the macroeconomic position.
Q23 Ms Keeble: May I just ask for
Sir Andrew's comments on the position of secured and unsecured
debt and projection on trends?
Sir Andrew Large: I do not think
I have a lot to add to what the Governor has been saying and obviously
the social aspect of this speaks for itself. It certainly is true
that I have been concerned about the rate at which domestic debt
has been growing as a whole and my concern has been more that
as levels rise and as leverage rises, this makes people's behaviour
more vulnerable to shocks of one sort or another which could have
a macroeconomic impact. Those are risks, but that is not a central
case. Those are risks, but that is a rather different angle to
the question that I think the Governor was really answering.
Q24 Ms Keeble: I just want to ask
one further question about your opening comments, Mr King where
you remarked that one of the factors which would impact on future
economic growth was the flow of migrants; you said that had impacted
in the recent past and it would again and you were quite muted
in your comments. I wondered whether you were expecting there
to be some change or exactly what those remarks referred to and
how serious you think that problem is, whether it is a major impact
or whether it is quite a small issue.
Mr King: In the last couple of
years—three years—we have noticed increasingly from
employers around the country that when we asked them how they
cope in such a tight labour market without pushing up wages they
say they could find labour when they really needed to fill particular
skills gaps. One of the sources to which they have repeatedly
referred is migrant labour, particularly from Eastern Europe,
the new member countries of the European Union. That has helped
the economy to continue growing without upward pressure on wages,
which would otherwise have forced us to raise interest rates further
than they actually went. The consequence of that is that I should
expect the flows of migrant labour to be responsive to the state
of the UK economy, that more people would come in if the labour
market were buoyant. If the labour market were to slow down, then
I would not expect the inflow to be anywhere near as great. I
think that is providing a safety valve for pressure on the economy
which will automatically unwind if the economy were to weaken.
Q25 Ms Keeble: Obviously this is
an issue of huge political concern as well. It is a very sensitive
issue. I wondered whether you were thinking in any way that changes
in approach or policies on the flow of migrant labour would have
an impact on the economy, whether the reverse would be the case.
What you have argued is that the flow of migrant labour met the
economic demands of the labour market. If there were changes here
which sought to restrict the flow of migrant labour, would that
have a negative effect on the economy?
Mr King: If we had no flows of
migrant labour from the accession countries, then it would certainly
affect the way the labour market operated and in the recent past
it would probably have led to faster growth of average earnings
and hence probably higher interest rates than we otherwise had.
I do think that this is a sensitive issue and that is why my comments
are muted. What I am trying to comment on is not whether things
are good or bad, right or wrong, but merely pointing to facts
about the UK economy. One of the facts about the UK economy that
we have all noticed going around the country is that employers
have been able to use migrant labour to fill gaps in skill shortages,
thus enabling them to continue growing output in a way that they
wanted to and to ensure faster growth in the economy. That is
a fact.
Ms Keeble: On that sensitive issue, the
facts are very helpful.
Q26 Peter Viggers: The Government
Actuary's Department's most recent population projections have
revised up estimates of population growth, but you say that the
new estimates have not led the MPC to revise materially its assessment
of past or current potential supply. A couple of questions on
that. Will you be revising your future estimates based on migrant
figures? May I ask you to comment on the fact that whilst your
inflation reports are, in most cases, very specific and accurate,
the information about migrants is very much less clear-cut than
most of the information we have and indeed, when we asked Paul
Tucker about international migration and wage pressures, he said
that the pressure on inflation was based largely on anecdote.
The question really is: are you intending further research in
this area and do you anticipate that your further research will
in due course lead you to revise future estimates?
Mr King: Two points on that. The
first one is that the reason why the latest official figures have
not led us to revise upward our estimates of the labour force
is because we had already factored increases of that order of
magnitude into our estimates before, based partly on our own experience
of going round the country and talking to firms, but partly on
some of the earlier published figures from official sources on
the number of people applying to work in the UK from Eastern Europe.
We had actually produced some numbers for ourselves. I referred
to it in a speech I gave in June, where I said that the growth
rate of the labour force had effectively doubled in the last couple
of years as a result of the extra flows of migrant workers. I
do not think that the latest figures add anything to that. You
might argue that some of the figures which came out recently may
perhaps show that, if anything, the flow is increasing rather
than reducing, because that reflects the buoyant labour market.
What is important is not to assume that this is in some sense
an exogenous flow from outside, which will keep coming in independent
of the conditions in the UK economy. It is a very interesting
development, because it does mean that our labour market works
in a rather different way and it means that some of the traditional
jargon which economists used to use like the output gap is somewhat
less firmly based than it used to be. We need to think carefully
about that and the Committee has been doing exactly that. In the
end, the only source of data on this is going to come from official
figures, so I do not think the Committee can easily claim it can
put numbers on the flow of migrant workers itself. What is important
is that we know what to look for. One of the things that I learned
by going around the country, I felt this very strongly, was that
when I talked to groups of business people and asked how many
in the room had employed people from Eastern Europe in the last
six months, I started to notice that 50% were putting up their
hands and saying they had and I started to realise that this was
a phenomenon that was actually having an impact on the economy.
I think we were one of the first institutions to draw attention
to this. That did not give us a very good handle on how big the
issue was; it gave us some feel for it and then we started to
probe directly into the official figures ourselves and to try
to build up some estimate. That gave rise to the figure I put
in my June speech, well before the publication of the data which
were referred to earlier.
Q27 Peter Viggers: Turning to energy
and specifically to oil and gas, you referred to the increase
in oil and gas figures falling out of the equation. Have there
been any changes in recent prices, I am thinking specifically
of gas prices, which would cause you to fear that this will be
a factor which needs to be taken further into account?
Mr King: It is certainly something
that we shall have to monitor very carefully. Since August, in
terms of oil prices, there have been no surprises; oil prices
have fallen back a little. Broadly speaking, we have not learned
a great deal since August in terms of oil prices. The position
on gas prices in the UK is, unlike the movement in oil prices,
perhaps rather specific to the UK. That is something we shall
have to watch very carefully and if we see, month by month, that
there are changes to the path that we had expected, of course
that will be factored into our short-term path for retail price
inflation. We shall have to consider whether it affects the longer
term. If there were to be cutbacks to industry and that were to
affect the growth of output, that would be a supply-side effect
that we should have to take into account. It is very difficult
at this stage to know what effects those might be.
Q28 Peter Viggers: Private sector
labour productivity has been really quite disappointing for ten
years, but on other hand the UK economy is benefiting from productivity
gains from investment in information and communication technology.
Do you think that the gains from new technology will impact on
productivity generally to a great extent?
Mr King: This is a very difficult
question to answer, so I shall call on some of my colleagues to
help me out. This is one of the factors that we think about when
trying to explore where long-term productivity growth will go.
I shall just make two points on it and perhaps ask Kate and Rachel
whether they would like to comment. In the short term, we have
seen very weak productivity growth in the first half of this year
at an annual rate of only half a per cent a year. One possible
explanation of that is that the official data on output growth
are too weak and that the employment data are pointing to a stronger
growth rate of output, rather than such a weak growth of productivity.
Alternatively, it could be that firms are hoarding labour—expecting
the slowdown at the end of last year and beginning of this to
be very temporary—and do not want to lay people off in a
tight labour market and face the difficulty towards the end of
this year and into next year of trying to get back people whom
they need when the labour market looks very tight. That too would
explain the weak level of productivity growth. Looking ahead,
we have not seen over the past ten years any of the pickup in
productivity growth from investment in ICT which has been visible
in the United States economy. We start from a position where underlying
productivity growth has not fallen back, but it just has not picked
up in the way that it seems to have done in the United States
and some of the Scandinavian economies. Whether that is because
of measurement difficulties—people find it hard to capture
it in the official data—whether it is because it has not
yet come through and will come through, or whether it is that
ICT investment actually takes a long time—you only really
see its benefits when companies have had a chance to restructure
the whole way in which they work and lay out factories and therefore
it will take a considerable period before it comes through—is
very hard to judge. I should like to hear what Kate and Rachel
have to say about it.
Ms Barker: I am not sure I have
a great deal to add to that. In a sense the difficulty always
with looking at productivity data is distinguishing between trends
and cycles. What we are seeing at the moment probably are some
quite big cyclical effects in productivity. Towards the end of
2004 we had a period where productivity growth appeared to be
very strong and I was relatively optimistic that we might start
to see some of the impacts from new technology feed through. At
that time I was optimistic that perhaps we had started to see
more sustained pickup in productivity. Consequently I have been
rather disappointed this year that we have had this very clear
downturn, suggesting to me that the pickup last year and slowdown
this year are primarily cyclical phenomena related to the hoarding
of labour, as the Governor has discussed. I am puzzled about why
we have not seen a trend pickup in productivity consequent on
the improvement in ICT and I find it difficult to add any more
to what the Governor has already said.
Ms Lomax: There is a small section
in the August Inflation Report on this very subject on
page 23 and a footnote on a recent working paper which the Bank
has published on productivity growth in UK industries over the
last 30 years and structural change in the role of ICT. It has
been an active area of research by Bank staff and they have done
a lot of looking for the sort of effects which have been found
in the United States; so far with no success, alas.
Q29 Susan Kramer: I should like to
try to explore a little bit some variances in views on interest
rates. Sir Andrew, you voted for increased rates in March, April
and May but in June, you resumed voting for no change in interest
rates. Can you give us a little bit of insight into that?
Sir Andrew Large: My voting pattern
earlier in the year tended to be on the upside because of two
factors. I continued to be concerned about the rate at which household
debt was building, which could give rise to vulnerability at a
later date and I was also becoming increasingly nervous about
the oil price which was, of course, rising at that time. As to
why I voted differently one month from another, other factors
intervene, other data comes along and there are so many factors
which you take into account month by month that I have found myself
on occasion wanting an increase one month and then finding myself
in a position where, the data having shifted sufficiently, next
month it would make no sense to be voting for a rise. I am afraid
that I cannot recall precisely what the changes were that had
taken place to cause me to vote for no change afterwards, but
those were the reasons I voted for rises earlier on.
Q30 Susan Kramer: Just looking at
the main minutes, there is a note that a rise in the repo rate
would also help to slow households' persistently rapid accumulation
of unsecured debt. From what you have just said and putting those
two together, might you have a slightly different view perhaps
from some others of the impact of unsecured debt? You are a little
more concerned perhaps about the impact of unsecured debt on the
overall picture than some others.
Sir Andrew Large: Actually my
concern is not confined to unsecured debt. My concern has been
across the board in that, beyond a certain limit of leverage that
people have, a situation arises whereby any shock which comes
along is more likely to impact their consumption and behaviour
than if they have lower levels of debt. No, my voting pattern
has not been addressed specifically at unsecured debt as opposed
to secured.
Q31 Susan Kramer: I was just going
to ask Rachel Lomax. You made a decision to vote against the cut
in interest rates in August. Can you give us a little bit of insight
into why you made that decision?
Ms Lomax: I had been voting to
hold interest rates for some time and I voted to hold again in
August. I found the August decision quite difficult. Earlier in
the year I was conscious that the economy was slowing down, but
I was very mindful of the fact that we had raised interest rates
precisely in order to slow things down because we felt the economy
had been growing unsustainably fast relative to its supply potential.
During the first half of the year I was aware, but not surprised
perhaps, that the economy was slowing down because I had regarded
it as growing unsustainably fast earlier and in fact the subsequent
revisions to the data reinforced the fact that it had been growing
unsustainably fast. I was not convinced that the slowdown had
led to the emergence of any significant degree of spare capacity.
In other words, I thought that we probably did not have really
much of a negative output gap; I did not feel there was any rush
to cut interest rates from that point of view. I was increasingly
disturbed at our failure to forecast the pickup in inflation which
actually took place from September onwards. We were expecting
some pickup in inflation, partly associated with the oil price
rise, but we kept on getting it wrong and I found that very unsettling.
I wondered whether that meant that there was more steam in the
economy than we had previously understood. In that situation,
I thought that it was neither necessary nor desirable to cut rates.
I was also bothered about validating what was a growing market
expectation that there was not just going to be one cut in interest
rates, but a sequence of rate cuts. Back in August when we did
the August Inflation Report, I think the market was pricing
in something like three cuts in 25 basis point interest rates.
Q32 Susan Kramer: As though you would
follow the Fed, as it were.
Ms Lomax: Exactly and indeed past
MPC behaviour. It is actually very unusual for a central bank
just to do one cut in interest rates and leave it at that; that
is not typical behaviour. I also felt that a cut in interest rates,
after a long period when you have been raising and then holding
interest rates, requires a bit of extra burden of proof; it is
quite a marked change in direction. I was worried about sending
a signal that we might be entering into a significant easing phase
at a time when I was not at all sure that that was the direction
that we ought to be going in, given the overall state of the economy.
Q33 Susan Kramer: May I just pick
up on this issue of spare capacity in the economy and the comments
that David Walton made earlier? You were in some way implying
that you are seeing that capacity issue somewhat differently.
The comments you made were that a big chunk of the adjustments
which have been made to the growth forecasts—I was looking
at some numbers and it looks to me to be about a third—is
basically business investment coming in at a far weaker number
than had been anticipated. Are we getting rather different views
perhaps about over-spare capacity?
Ms Lomax: Can we just establish
what period we are talking about? I am talking about the view
I held in August.
Q34 Susan Kramer: Okay. Have you
adjusted today?
Ms Lomax: Today, I think there
probably is a bit of spare capacity, but it is highly uncertain,
not least because of the uncertainty about the impact of higher
oil prices on supply. One can establish that demand has slackened,
but we have been quite puzzled about what has happened on the
supply side too. My central guess would be that there is a small
margin of spare capacity there, but there is a wide margin of
uncertainty around that. David may have a different view.
Mr Walton: What I should just
say is that back in August it was quite a close decision for most
of the Committee and you saw that in the vote; indeed Rachel made
the point about the markets pricing rates going to 4%. I should
hazard a guess that if you had asked any of us whether we thought
the rates would go to 4% by the beginning of next year, you would
have found a pretty unanimous agreement. The debate was very much
over whether we should be cutting by 25 basis points or not. My
own feeling at the time was that there were some downside risks
to economic activity and a precautionary cut would make some sense
in those circumstances. Since then, we have seen some weaker activity
numbers, but the encouraging thing is that it looks also as though
we may have seen a trough in growth and that the economy has not
continued to lose momentum. Secondly, I felt that, yes, inflation
had risen and was likely to go above target, but at least at the
time, the projections that we had suggested that inflation was
going to peak, maybe half a per cent above the target, and, given
that the target was symmetric, it seemed to me that was not a
bad outturn at all given this near doubling in oil prices which
we had faced. However, that said, with the economy starting to
gain a bit of momentum, it seems to me that it is right in current
circumstances to make sure that we do not see the second-round
effects come through the wage round which is about to kick off.
Q35 Susan Kramer: Perhaps I might
ask Kate Barker. I was just looking at an article from one of
the Lancashire newspapers of a recent speech of yours which certainly
sounds quite pessimistic; it certainly seems to look at a continuing
weakness, particularly on the business investment side. I do not
know whether I have characterised that absolutely, but you have
also voted more on the rate cutting side rather than the holding
side. I wonder whether you could help us through that.
Ms Barker: May I come back to
the general decision and make one or two comments? All members
of the Committee found it quite a difficult decision in August
and I certainly did. The difference between us was in some sense
narrower than perhaps the vote appeared. I did to some extent
share the concerns about what we were signalling about the future
path of interest rates, but I hoped that by dint of the Inflation
Report, we should be able to suggest that this was not necessarily
the start of a run of cuts. That was reasonably successful, the
market expectations have changed somewhat since August and now
in fact the market expectations are pretty flat. Further, I am
not quite so sure that I feel that after you have been moving
in one direction for a long time you actually need to have more
evidence to move in another. On the whole I tend to think that
if you want to make a move in interest rates, you should do it
sooner rather than later. In that sense, I am one of members of
the Committee who thinks we should move soon and those factors
certainly weighed with me, alongside the short-term rates of growth
which David has already outlined, when we made the cut in rates
then. As to my views now, in the context of the interview I gave
I was trying to get across the point, firstly, that in the short
term I think consumer spending will remain relatively weak. It
has of course picked up a little bit since the beginning of the
year, but the evidence of the pickup is certainly not everywhere
in the economy; some parts of consumer spending do remain pretty
weak. As we move on into next year, we start to see a lower rate
of inflation, some improvement in real income, so the prospects
for pickup in the consumer are better. I was also reflecting in
that particular piece, because I was asked about the local area,
the fact that I had encountered in my meetings in that region,
a number of businesses who were rather gloomy about prospects,
and were rather gloomy about investment. I would not necessarily
generalise that to the country as a whole, but it is true that
in this recovery business investment has been rather weaker than
we would have expected. We have discussed this in a number of
inflation reports. The circumstances for businesses to invest,
however, in some senses are not bad, if you look at their cost
of capital or indeed if you look at their profitability. Looking
ahead, I think companies remain uncertain about prospects and
we may find that investment continues to be a bit weaker than
we expected, but I should not put it any more strongly than that.
Q36 Susan Kramer: I just happened,
for another purpose, to be looking at interest rates in the euro
zone compared with interest rates here once the euro zone had
settled in and there seemed to be almost a fixed 1% differential.
Then I took a look at the newspaper for rates pretty much 10 years
out and it is still there as a 1% differential. It is looking
to me like a risk premium. I just wondered whether you had any
comment on that.
Mr King: No, it is not. The average
10-year rate is lower than here because their current interest
rate is lower and is expected to remain lower for some time, reflecting
the weakness in the euro area economy. If you look at expectations
of where spot rates are thought likely to be in 10 years' time,
you do not see any evidence of a risk premium.
Q37 Angela Eagle: On higher oil prices,
we have had this huge doubling and we have managed to remain reasonably
balanced without any huge shock, but you discuss in some detail
your worries about the oil price and particularly the supply and
what effect that might have. Do you want to expand on that a bit
for us about your thinking of how the Committee can factor in
this possibly high and remaining high oil price?
Mr King: We felt we really ought
to understand as much as we could about what, as you said, is
a very significant development. We have not seen a doubling of
oil prices for a long time. If you had asked us in 1997 what development
in the world economy would give us most concern, it would undoubtedly
have been something like a doubling of oil prices. That would
have been one of the so-called supply-side shocks which would
push up inflation and dampen economy activity. It is the first
time we have really faced something of that kind since 1997. We
try to work hard to analyse the direct impact of the increase
in oil and energy prices on consumer price inflation in the short
run. That is not entirely easy to work out, but we have done our
best to try to work it out and we think roughly half of the pickup
of inflation over the last year can be attributed to that. We
have also had to think very hard about what the impact on the
supply side would be and Rachel referred to that. There are two
ways in which that might come through. One is that it could mean
that firms find that some of their capital equipment has now been
made unprofitable, because it is energy intensive and they cannot
easily, with that machinery, switch away from the use of energy.
That kind of machinery way well end up being scrapped which would
temporarily lower the supply capacity of the economy. I do not
think we feel we have seen enormous signs of that. I do not think
it is the case that going round the UK people have been saying
to me that much of their company equipment has been made redundant.
They have had to adjust to higher oil prices and they have tried
to do so. The other main way in which the supply side could be
affected would be if it turned out to be case that in wage bargaining,
wage demands were to rise and people were to say that unless they
were compensated for this increase in oil prices, then they would
not work as hard or do as much overtime as they did before. That
effect could clearly diminish the supply-side growth rate of the
economy and people felt in the 1970s that it did do so. Fortunately,
we have not seen any signs of that so far. We have not seen that
earnings growth has risen to compensate for the pickup in inflation
in the last year and that is very important. Perhaps because it
is possible to recruit labour from elsewhere we have seen that
firms have been able to continue to employ more people without
having to bid average earnings growth up. That is one of the most,
if not the most encouraging signs in the economy in the last year
or so. It is one about which I personally had concerns a year
or two ago—and I expressed them—but those concerns
have not materialised. As I said in my opening statement, it is
still too early to be sure. We are going through a pay round over
the next few months and it will be very important that in that
pay round wage rises do not pick up to compensate for the rise
in inflation. We all have to bear this higher price of energy.
If we get through the pay round without any adverse consequences,
then I think we shall be more comfortable in thinking that the
supply-side consequences of the doubling in oil prices will be
not as large as they might have been and, indeed, as they probably
were when we previously saw a doubling of oil prices.
Q38 Angela Eagle: Rachel Lomax, do
you think that the second-order effects will be properly picked
up in statistics so that come the next few meetings, if there
were a second-order effect you would be able to take it into account?
There is this issue of timing, when you take higher oil prices
into account. Is it the case, as seems to be increasingly happening,
that the issue of migrant labour and this safety valve, as the
Governor called it in response to an earlier question, is actually
mitigating the potential downside effects of big exogenous supply-side
shocks?
Ms Lomax: It may be that migrant
labour is helping to change the behaviour of the labour market
in the way that the Governor suggested, so that is one reason
why we might get through this oil price shock in better order
than we did in the 1970s. You asked how quickly we might pick
up any second round effects and that is a slight concern to me.
The data on settlements, for example, come in dribs and drabs
and it is very difficult to know until some time after the event
exactly what the overall picture is. We monitor data in enormous
detail, but, even so, you can never be completely certain. That
is one reason why, to be honest, I am inclined towards thinking
that you ought just to err on the side of keeping policy a little
bit tighter than you might otherwise have done. When the second
round effects have kicked in, it will be some time after the event
that you find out, and by that stage the horse is well and truly
out of the stable door.
Q39 Angela Eagle: What about if we
move into a world, which I think is possibly likely, of permanently
higher oil prices because of the huge increase in demand which
is coming from India and China and instead of having a sudden
shock, businesses then have to start factoring in the idea that
oil prices are going to stay where they are now or go higher on
a more permanent basis? A recent CBI survey revealed that 12%
of employers had passed the energy prices on, but a much larger
number of them were thinking of passing those prices on to consumers
if oil prices remained high, and clearly that is a lagged effect.
What would be the appropriate response to living in a world of
permanently high oil prices?
Mr King: We start from a position
where financial markets believe that oil prices are likely to
remain roughly where they are. They may fall back somewhat and
of course those in the oil industry would say that they will surely
fall back quite a lot more. The futures curve over the next five
years shows that there will be some small fallback in oil prices,
but not to go back to where they were. The scenario you ask us
about is thought to be probably the most likely one, so it is
important. We have tried to make some judgments so far about how
much of the increase in oil prices to date has already come through;
not all of it, but a good part of it. We feel that judgment is
consistent with the fallback in consumer price inflation that
we saw in October. It was only a small fallback; we must not run
away with the view that it is going to keep on falling. The central
view is that it will fall back for a few more months but it could
pick up again; we shall just have to wait and see. Where we could
go wrong is if it turns out to be the case that much of the oil
price increase has not yet come through, that the pickup in inflation
over the past year was more the result of higher demand pressure
and weaker supply growth than we thought and that we shall see
more upward pressures on inflation over the next year. If that
were to materialise, and I stress if, because it is not our central
view and it has not come to pass yet, that is one of the upside
risks and we should have to respond. If we see the upside risks
materialising, then policy might need to be tightened. We think
risks are evenly balanced at present and it may go the other way,
in which case policy would need to be eased. We shall just have
to see how it works out.
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