Examination of Witnesses (Questions 20-39)|
27 MARCH 2007
Q20 Mr Newmark: Does anybody else
want to comment on that? Shall I move on to housing? How would
you currently describe the housing market?
Mr King: Give me a range of adjectives
you think might be appropriate here, and I can tell you!
Q21 Mr Newmark: I will start off,
then. Do you agree with the IMF's assessment, for example, that
house prices are overvalued and that there is a risk "of
an abrupt downward adjustment"?
Mr King: It is always easier from
a long distance to make judgments about over or undervaluation.
It is clear that if you were to look at the housing market in
terms of prices relative to a multiple of earnings then house
prices look much higher than they were some years ago, but I am
not sure if that is the right criterion. In the end, I suspect
that to understand the housing market two very simple words help:
supply and demand. On the demand side we have seen, as with other
asset markets, very low, long-term real interest rates set in
the world capital market. That, you would expect, would lead to
a rise in the prices of all assets; there is no reason why housing
should be an exception to that. Secondly, we are seeing, on the
demand side, significant migration that is also bound to increase
the demand for housing. We have the country's expert on my right-hand
sidewho has pointed to some of the shortcomings on the
supply side of the UK housing market. If you put those two things
together then, perhaps, it is not very surprising that house prices
have been high. Where they will go in the future I do not pretend
Q22 Chairman: I wonder if we can
bring in Kate, as she is the expert. Are you disappointed at the
lack of progress so far on that?
Ms Barker: Am I disappointed at
the lack of progress? Certainly, it has taken quite a long time
to produce some of the recommendations following the report on
the housing supply, which, after all, I published three years
ago. But I do not think it is surprising. Things do move quite
slowly and it was important, for example, to change Planning Policy
Guidance 3 into Planning Policy Statement 3; something which,
I think, made considerable improvements. That did take time; it
was right to take time, and to get it right. It is also true that
the industry, having been running at a relatively low rate, would
have had difficulty in pushing up supply much faster. It is the
case that the supply of housing has been rising, certainly if
you look not just at new-build but net additions (if you take
conversions as well as new-build and then subtract demolitions).
That has actually risen quite a lot and quite steadily, and is
rising pretty much in line with what the Government was aiming
to achieve when they produced their forecasts in December 2005.
I think things are moving in the right direction. I was never
under any illusion that the housing market supply was going to
resolve itself overnight or even over three or four years.
Q23 Mr Newmark: So, just to flesh
that out a little bit, if we strip out, obviously, the people
in the City who are pushing up a particular area geographically,
if we go to where average house prices are, do you see any noticeable
changeor what does your analysis say on a regional basis?
Are things going on on a regional basis that we should be aware
of or concerned with, with respect to housing?
Ms Barker: I do not think the
picture on a regional basis necessarily, in terms of affordability,
as measured in the rather crude, price/income ratio way, is very
much different to, in some cases, that in London. It is still
very difficult for people further down the income bracket to get
on what is called "the housing ladder" and particularly
difficult for people who have no access to inter-generational
flows of funds. I think the two things significant to from the
big rise in house prices, (largely founded in lower long-term
rates) have been a big shift in capital to people who own homes
and away from those who do not, and also a big shift in housing
wealth inequality between people whose families
Q24 Mr Newmark: So, by definition,
what you are saying is, certainly at the lower end of the spectrum,
house prices look like they are overvalued but they are overvalued
because of a lack of supply. Is that what you are saying?
Ms Barker: I do not think I am
saying they are overvalued, because the combination of lower long-term
rates and the relationship between supply and demand provide pretty
good reasons for most of the rise we have had. It is possible
that on top of that there is a small, slightly more speculative
element in buy-to-let, but I would certainly hesitate to say that
house prices were overvalued.
Q25 Mr Newmark: If I can turn to
borrowing, unsecured lending growth appears to be diminishing,
according to your latest report that I saw, while secured borrowing
has continued to grow fairly strongly. One explanation has been
that banks are tightening their lending criteria. How widespread
do you think such tightening has been and what is the chance of
such tightening becoming more widespread?
Mr King: There is no doubt that
the rate of unsecured borrowing growth has fallen, most extremely,
I think, in the case of credit cards, where two years ago credit
card borrowing was growing at the rate of more than 20% a year
and now it is growing at between 2 and 3% a year. So a very significant
fall in the rate of growth of credit card borrowing. To be honest,
that is probably a welcome development. We have commented here
before that we think that the developments on the secured debt
side have largely followed development in house prices and have
not given rise to an experience of default or mortgage arrears.
The housing market is still a very safe form of lending for the
lenders. However, it is in the unsecured market where we have
seen the problems of personal debt. Both from the borrowers' side
as well as the lenders' side, there has been a recognition that
those rates were unwise, and growth rates have really tailed off
Q26 Mr Newmark: The fact that there
is something like £1.3 trillion of loans out there, does
that give you some cause for concern, or do you simply say: "Actually,
it doesn't bother me; what I really focus on is the default rates,
and as long as people can afford it they can keep borrowing and
Mr King: In terms of housing debt
what matters, really, is the relationship of the debt to the house
value, allowing a pretty wide margin for fluctuations in house
prices as well as their ability to service the mortgage. What
we have seen is that with much lower interest rates in recent
years it has been easier to service mortgage debt, and that has
made it possible for people to borrow more in order to purchase
houses of a higher price, but we have not seen an adverse experience
in terms of repayment or arrears. That is a decision best left
to those households themselves. It is on the unsecured side that
we have seen a number of problems of household debt and difficulties
that many households have got themselves into. So, both the borrowers
and the lenders have been adjusting to that.
Q27 Mr Newmark: If I take what you
say, you are saying there has been a huge amount of lending historically,
and the fact that there has been some tightening (not wanting
to put words in your mouth) in the sub-prime or the unsecured
market, should I say, is probably a good thing. I am just curious:
what are the consequences of a widespread tightening of lending
criteria? Is there an impact on the economy? Is there not? Obviously,
there is an impact on people personally.
Mr King: The impact you would
see would be in terms of the growth of borrowing overall. As you
pointed out, given that secured borrowing, which is the vast majority
of overall debt (something like 83% of total borrowing is in the
form of secured borrowing), the growth rate of debt overall and,
hence, the impact on the economy is largely determined by the
secured side, not the unsecured debt.
Q28 Mr Love: Following on from that
and some of your earlier answers, Professor David Miles has suggested
(he is another expert in this area alongside Kate Barker) that
there is an element of speculation in house prices, and that at
some stage that has to come out. If you look at the problems in
America, the problems have arisen because house prices are falling.
Do you have any concerns about that?
Mr King: I do not pretend to be
able to forecast house prices, and most of those who try to do
so have been proved wrong in recent years. Let me not go down
that road. Let me ask the question: if house prices were to fall,
what would be the consequences? If they were to fall by a relatively
modest amount then I do not think the consequences would be very
severe, because you would find, still, a very small number of
households would find themselves in a position where they were
described as having negative equity. As long as they go on servicing
the mortgage, if indeed they would choose to do so, I do not think
there will be any major difficulty. If there was a very large
fall in house prices, which I think all of us think is unlikely
but no one can rule out entirely, then the problem is much more
severe. However, I think it would be wrong to look at it as a
problem of housing, because you would have to ask the question:
why did the price of houses fall so sharply? In large part, that
would have to reflect some other shock to the economy as a whole.
We have not seen that so far. If there were a shock to the economy
as a whole, obviously, we would take some action to offset that
shock but, so far, as I say, the simple-minded, forward projection
of house price-to-earnings ratio has not been a very good predictor
of what would happen in the housing market. There are very good
reasons for that in the last few years: the very low level of
long-term interest rates ought to push up all asset prices, and
it has, and housing is no exception to that. If interest rates
were to return to historically more normal levels then all asset
prices would adjust, not just house prices, and then that would
be a development that we would have to deal with. On the supply
side, Kate has drawn attention to some of the difficulties. Again,
I think, in any individual market you do not go very far wrong
by thinking in terms of supply and demand.
Q29 Mr Breed: Turning to domestic
demand, we have been provided with a very helpful summary of the
comments made in the November and February Inflation Reports on
the components of GDP. On that basis, do any of the components
of GDP forecast, such as consumption or net trade, give you any
particular cause for concern?
Mr King: Not cause for concern.
I think we have seen the economy develop, as I said at the beginning,
in a remarkably steady way over the past five quarters. There
are signs of a modest rebalancing of demand with consumption growth,
if you average out the experience of the last five quarters, growing
close to, maybe a little bit below, its long run, historical average.
Business investment, clearly, has now recovered and has been growing
quite rapidly and we are beginning an adjustment now towards lower
growth rates of public spending. The data on net trade are almost
impossible to interpret because they are dominated by the effects
of fraud. But I think we are beginning to see some signs of rebalancing,
and I would welcome that. Overall, there are no obvious signs
for concern but, as I say, the central view in all this is not
one that is ever likely to materialise, and the role of the Committee
is to take one month at a time, to look at the news on that month
and to see whether the central projection is or is not materialising
and what new developments have occurred. We always have to be
alert to respond to those new developments.
Q30 Mr Breed: As you mention trade
and fraud, do you believe that the current Government's measures
it has introduced fairly recently are having any significant effect
on MTIC fraud.
Mr King: Fraud? We cannot judge,
but the numbers we have been given do show a substantial fall
in fraud towards the end of last year, but I do not think we are
the experts on fraud.
Q31 Mr Breed: No, I do not think
anybody is! On consumer spending, the recent data released suggests
weakness in the services sector combined with higher retail sales.
What is your opinion of the future path of consumption as you
see it, perhaps, over the next 12 months or so?
Mr King: As you said, the data
in the last few quarters have been quite volatile, but it has
been volatile in a particular way, with one quarter strong, one
weak, one strong and one weak. That is a classic sign of measurement
error in the data, and it could either be because spending is
being allocated incorrectly to one quarter and it should have
been given to the adjoining quarter, or it is because the seasonal
adjustment has become more difficult. We know, for example, that
people do not spend more or less simply because they are in Q1
or Q2; they may do because of the weather, and seasonal adjustment
is a proxy for that, but with changes in the meteorological pattern
that may affect the optimum seasonal adjustment. January was the
warmest January since 1916. Who knows, but if you talk to retailers
(which we do a lot) they never talk about: "This is the week
in the year when sales are weak or strong"; they say: "A
year ago the weather was wet, or warm, and hence you would expect
the year-on-year figures to be either higher or lower". So
they do put a lot of attention on the impact of weather. These
adjustments are very hard to make. As I said, what we try and
do is to look through this volatility, because it is very hard
to understand. If you look through it you see that what has happened
since the slowdown in the first half of 2005 is that consumer
spending has recovered to grow at, perhaps, a little bit below
but close to its long run historical average. I think that is
where we would expect it to go in the future, consistent with
a modest degree of rebalancing.
Q32 Mr Breed: So you believe that
the volatility shown is more of a technical measurement than it
is to do with the underlying
Mr King: I suspect so. There is
no obvious reason why people would want to spend in that volatile
way. Again, the big picture is that these are not dramatic degrees
of volatility, but I suspect it may well be to do with the measurement
of the data, or seasonal adjustment.
Q33 Mr Breed: Do you expect it to
continue or do you expect that to be a blip?
Mr King: Of volatility? Either
because it is measurement error or because of difficulties of
the seasonal adjustment, without being able to predict the weather
or what the factors are that are leading to the seasonal pattern,
I think it is impossible to know. Again, I do not think it matters
very to us, because we try and look through the volatility and
form a judgment about the underlying picture.
Q34 Mr Gauke: Was there anything
in last week's Budgetany of the announcements made therethat
might affect your projections for GDP or inflation?
Mr King: I do not think so. The
big picture is no; the Budget overall was neutral. I do not think
it affects our overall view of the path of fiscal policy. There
are some minor aspects that we will look at in more detail between
now and the next meeting. Some of the indexation of excise duties
comes into effect later this year than we had previously understood
to be the case and it is possible that because of the changes
in capital allowances there may be an incentive to invest earlier
than later. I do not think these are first order, and the overall
picture is that the Budget does not change our view about the
overall path of the economy or, indeed, fiscal policy.
Q35 Mr Gauke: Is the fact that the
borrowing figure was slightly higher than the Chancellor had previously
predicted something that you consider significant at all?
Mr King: In terms of the overall
picture, looking at the years ahead, there is no significant change
to the fiscal position. There is a shortfall relative to previous
expectations of North Sea revenues, but the overall picture, I
think, is broadly unchanged.
Q36 Mr Gauke: The Red Book predicts
inflation at a rate of 2% for 2007, 2008 and 2009, and this is
consistent with the external forecasts as well. In your Inflation
Report the external forecasters predict 2% for 2009-10. Is there
an assumption from the Treasury, in their projections, that there
will be a rise in interest rates before falling back? Or is it
not possible to say?
Mr King: That is a question you
must ask them, and no doubt they will come to you and you can
ask them what assumption they are making. For our own judgment,
I thinkand we saw this very clearly in the February Reportthere
is a good deal of uncertainty about the short-run path of inflation.
I think it is fair to say that around 2% is the broad judgment
that most forecasters have come to as to where inflation will
be by the time we get to the end of this calendar year, but it
does depend on the pace and extent of cuts in retail gas and electricity
prices. The cuts that have been announced since we published our
February Inflation Report are consistent with the judgment we
made in the report. Our judgment was that over the next six months
there would be the sort of cuts that have been announced. We also
assumed there would be further cuts to come, and we will see whether
that happens or not. The difficult judgment facing the Committee,
and the important one, is to look through this short-term volatility
of gas and electricity prices and try to judge where inflation
is likely to settle once we have seen our way through this. It
is quite tricky. In the last year we saw inflation pick up, in
part, because of higher energy prices. This year, if those energy
prices had stayed where they were, inflation would have come back
again because there would not have been the base effect. But because
they are now falling inflation will come down faster than we had
previously thought. Equally, however, once you get into 2008,
unless gas and electricity prices continue to fall, there will
be a bounce back up again in inflation. So we have got to see
through the increase last year, the sharp falls this year, the
bounce-back in 2008 and try and see where all this leads to. That
is not easy, and that is why it is perfectly easy to understand
why there are differences of judgment on the Committee.
Q37 Mr Gauke: Sir John, can I ask
a quick question, with your experience within the Treasury? To
what extent are the Treasury inflation projections independent
from the Bank of England, or do they rely very heavily upon the
MPC and the Bank of England's projections?
Sir John Gieve: I think they do
their own forecast, but it would be quite a big thing if they
came to a very different view from us. So I think they do take
our projection seriously.
Q38 Chairman: I have a question for
the other members, at the moment, Governor, and it is to do with
the money aggregates. One of our contributors has highlighted
the growth of the money supply, saying that it has been very high,
13-14%, in the recent past. What should the MPC make of the growth
in the money supply at a time when consumer price pressures appear
to be ebbing? How is it giving weight to such considerations when
immediate inflationary pressures also seem to be ebbing? Can I
ask other members: to what extent do you think the current growth
in the monetary aggregates is providing information on the future
path of inflation? Let us start with Dr Sentance.
Dr Sentance: I think you can see
there are two influences on the money supply. First, it can be
reflecting the demand conditions in the economy and, second, it
can reflect portfolio shifts in the investment community. A lot
of the growth that we have seen has been in the other financial
institutions, so there is certainly evidence that the composition
of some portfolio shifts have been playing a part in that growth
of the money supply. I think the way I would interpret it is to
say that at a time when demand has been picking up across the
economy over the course of the second half of 2006, it is certainly
something we need to watch closely. The most recent figures have
given slightly mixed signals; there did appear to be a deceleration
but I think the last month was a little bit stronger. So my approach
would be, certainly, to be watching it closely but to have an
open mind about the extent to which this is reflecting demand
conditions or portfolios shifts, and to use other information
about the state of demand in the economy to help inform my judgment.
Q39 Chairman: But all cannot be dismissed
as technical in origin, in that it corresponds to increased holdings
of money by financial institutions, which may have no relevance
to economic activity. So, you would not dismiss it completely
as just technical.
Dr Sentance: Certainly not. No,
I would not be in the position of dismissing the monetary data,
but I think we need to be careful in interpreting it. Sometimes
it is giving us useful signals. There was a tendency, for example,
in the late-1980s to dismiss high monetary growth because in the
early-1980s it had given some slightly misleading signals. It
is something we need to take into account, but we should look
at it alongside what other indicators are saying about demand
conditions, in particular, because that is the sense in which
I think it would be a worryas a signal of strong demand
conditions, both currently and in the future.
Ms Lomax: I am a bit more sceptical
than that. I find it very difficult to see much information in
short-term movements in any of these monetary aggregates for movements
in inflation over the next couple of years or so. I do not think
anybody has estimated a stable demand for money function in the
UK for many a long year, and even in the days when we thought
there was a stable demand for money function we had a lot of difficulty
in setting monetary policy with reference to the monetary aggregates,
as I remember only too clearly from my period working on these
issues in the Treasury in the 1980s. So I am pretty sceptical
about the extent to which, looking at these figures from month-to-month
or, even, quarter-to-quarter, we can say very much about what
they are telling us about future inflation. In an economy with
a sophisticated financial system, where there is a lot of financial
innovation, these aggregates, which we have defined as moneyand
there is a whole industry around exactly what you measure and
call money it is incredibly difficult to define what you mean
by money, but assuming you have settled on some definitionsthe
simple relationships are very difficult to determine. In a much
less sophisticated economy, which is much more controlled, where
it is clear what money is, I think there may be a stable demand
for money and monetary aggregates have some predictable relationship
with future inflation. They are much easier to get a handle on.
But in the sort of economy that we live in at the moment one has
to be a bit more sceptical than that. I am afraid I am not a believer
any more, having been a believer 20 years ago.