Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 20 - 39)



  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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