Examination of Witnesses (Questions 60-79)
MR MERVYN
KING, MS
RACHAEL LOMAX,
SIR JOHN
GIEVE, MS
KATE BARKER
AND DR
ANDREW SENTANCE
27 MARCH 2007
Q60 John Thurso: You mentioned the
frequency of purchase and I think the ONS have undertaken some
work on that. How much do you take that into account in the MPC's
deliberation or is it just a `take note' factor?
Mr King: I think it is a `take
note' factor because this difference is really something that
has been particularly large in the last two years and I would
expect that to unwind.
Q61 Mr Love: Governor, first of all,
I should apologise. There is nothing worse than asking a question,
getting half-way through and having to come back to it at the
end, so I do apologise for following up on the question I asked
you earlier on. In response to Mr Thurso on the US sub-prime market,
I agree entirely that some of the exotic practices there are not
being replicated over here, but there are certain trends that
are going on. The proportion of sub-prime lending and totally
new lending is going up and the proportion of, shall we say, riskier
characteristics of the people they are lending to in the sub-prime
market seems to be going up, and there is some concern about this.
Is that something that you are monitoring and do we need to be
taking some action to restrain that at the present time?
Mr King: Well, we do regularly
monitor it in John's area and also in the markets area of the
Bank. We hold meetings with the lenders to discuss what is going
on and whether they have changed the degree of restriction which
they impose and the conditions which they impose on lending. We
are, in fact, going to start to publish before long a new survey
of lenders in the credit market. I do think that they are very
conscious of their risk experience and they will not have been
unaware of the problems that have occurred in the US market. I
think they do look very carefully at what happens here, but of
course, if they were to refuse to lend altogether, I am sure that
many members of your Committee would be saying, "Well, why
is it that people on low incomes can't get mortgages?", so
it is important that people have access to a competitive mortgage
market, and I do think the lenders are very conscious of how risky
that may or may not be. After all, most of those households try
very, very hard to meet their mortgage obligations, the last thing
they want to do is to fail to meet their mortgage obligations,
and I think it is no accident that the problems we have seen in
repayments of debt have occurred not in the mortgage market, but
in the unsecured market, store cards, credit cards and so on.
Q62 Mr Love: I understand that, but
I think it was The Economist at the weekend which
was pointing out that, whilst all these problems are occurring
in the US, the amount of money that is flowing into sub-prime
areas in this country still continues to increase. Is there not
some concern about that? I know the experience is not exactly
replicated, but we do not appear to be learning the lessons.
Mr King: All I can say is that,
if we look at the latest data and ask the question, "What
fraction of new mortgages are bigger than 90% of the value of
the house?", that figure has risen somewhat, but it is still
below 30%. In the early 1990s it was over 60%, so I think we are
a long way away from a situation in which mortgages are being
granted on those risky terms.
Q63 Mr Love: If I can move you on
to business investment, the Budget suggests that there will be
a significant continuing increase in business investment and I
think the Chancellor proclaimed that this was the start of the
rebalancing of the economy. Do you take as optimistic a view and
do you think the economy is beginning to rebalance or are we still
too dependent on our consumption?
Mr King: I think we are beginning
to see a rebalancing certainly between consumption and business
investment. Part of the strength of business investment last year
was investment in the North Sea which, because it led to times
when the plant was out of action, also reduced production and
revenues, but not all of it. Business investment has been growing
strongly and I think we would expect that to continue, so I think
I would take the broad view. I think the difficulty in judging
how far the rebalancing has gone is on the trade side where we
have not really seen much of a change yet, but no doubt in due
course we will see some, but it is very hard to predict when that
will be. Consumption is no longer growing at the rate that it
was in the late 1990s and early 2000s, it is growing at a completely
sustainable rate, and I think that business investment, after
a period when we were puzzled why it had not picked up, has picked
up now and is growing quite strongly, so there are certainly some
genuine signs already in the data of some rebalancing. The uncertainty
is as to how far it will go and whether it will actually reach
the trade side.
Q64 Mr Love: If we look forward,
does it not mean that, if consumption continues, government expenditure
is going to decline somewhat?
Mr King: The rate of growth, not
the level.
Q65 Mr Love: Does that not mean that
we need to be making that up on our trade position, yet, looking
out there at Europe in particular, it does not look as if trade
is going to be able to fill that gap?
Mr King: I think there are two
things to be said about that. The first is that the euro area
is now growing much more strongly than for some while and indeed
in the last few months we have seen good news on the euro area.
Whereas the growth rate in the US has been revised downwards,
that in the euroarea has been revised upwards. I think that area
is producing more good news than for some time. The second is
that in terms of our overall current account, although we have
a trade deficit, what we seem to have been able to do is to pull
off the trick of earning a higher rate of return on our assets
abroad than we are paying on our liabilities to those who own
UK assets but live abroad. We have been earning a surplus there
which has helped to offset the deficit on the trade account. How
far that is sustainable remains to be seen, but it has certainly
helped so far. It is unlikely to change dramatically or very quickly,
but in the long run I think we will need to see some rebalancing
of the economy to reduce the trade deficit, I have no doubt about
that, but it is very hard to know when and there seems no immediate
pressure to bring that about quickly because, if there were, then
I think you would see some downward movement in the exchange rate
leading to the expectation of a gradual adjustment.
Q66 Mr Love: Earlier in the year,
you were expressing concern about wage settlements, that real
disposable incomes were not rising and RPI inflation on which
most are based was quite high. Are you still concerned? Is the
outlook now much more benign than it was?
Mr King: I think it is too early
to judge on that and I think that was always one of the risks
which we identified. There is certainly no sign of that risk materialising
at this stage and nothing we have seen so far would suggest that
it has materialised, but I think it is too early to draw any strong
conclusion on that front.
Q67 Mr Love: What is the evidence
you are getting from your people in the regions?
Mr King: That there is some modest
pick-up in settlements relative to last year, although certainly
less than would have provoked our concern, but, as I say, we have
not seen the full results yet and, therefore, I would not want
to draw a strong conclusion at this stage.
Q68 Mr Breed: I want really to go
back to the regional disparities, I suppose. There is some sort
of feeling that pay settlements are raising much more pressure
to increase pay there. What evidence do you get? With what sort
of regularity do you get the evidence from your regional agents
in terms of specifically what they are seeing on the ground in
different parts of the country? Obviously I am concerned very
much with the south-west of England, but it is very different
from here obviously and the other parts.
Mr King: I think it is very different
in different sectors and industries rather than in different regions,
as such. It is up to us how often we get the data from our agents.
We always ask them to do a regular annual survey to coincide with
the pay round, although I think we have come to the conclusion
that the concept of a pay round is no longer as relevant as it
was in the private sector at least. It still is relevant in the
public sector, but less so in the private sector, but, as I say,
our general view is that there does not seem to be very much change
compared with last year.
Q69 Mr Breed: Do you have a comment
on the suggestion that in the public sector people are going to
get paid differentially for the same job, depending on where they
live?
Mr King: I think that is a question
you will have to put to those responsible for the public sector.
Q70 Chairman: We have put it to the
Chancellor for the past few years! Could I ask the question about
RPI because it is at its highest rate for 15 years and I wonder
if I could address this to everyone, the concern about it feeding
into pay settlements. Do you regard it as a temporary phenomenon
and what account of the RPI do you make in your deliberations?
Ms Barker: Well, it is certainly
the case that people often talk about RPI as being the index that
determines pay settlements, although in fact, if you look back
over history, it is by no means a one-to-one linkage and I am
personally rather sceptical of the idea that it does influence
pay settlements. The main influence on pay settlements almost
certainly is demand and supply in the labour market, and we have
talked about why migrant labour in particular has eased off skill
shortages that were probably otherwise emerging in quite a number
of industries. I was in the North East last week and I was very
struck by the fact that, of the firms we talked to about pay settlements,
the vast majority said that they were settling at, or very little
different from, the rate at which they settled last year, despite
the fact that RPI is so high. So, whereas RPI may very well be
the starting point, particularly in a negotiation where unions
are involved, it certainly is not the finish, but the finish depends
on how the company is doing and it depends on demand and supply.
I was always somewhat sceptical that there would be a direct feedthrough
to settlements, but I did recognise that as a risk and it was
indeed one of the risks I took into account in voting for higher
rates in January, although I have to say so far the evidence is
that it has not been realised, but we are a long way from knowing
the full story about what has happened to settlements in the first
half of this year.
Q71 Chairman: So you are not sure
if it is temporary or not?
Ms Barker: The rise in RPI?
Q72 Chairman: Yes.
Ms Barker: Well, the rise in RPI,
the rise and the other indices will be affected very much by what
happens to utility bills over the next few months. The expectation
is that we will see some fallback from this very high level.
Sir John Gieve: I think over the
medium term these indices tend to move together. But certainly
RPI is the best-known price index and, therefore, it could have
an influence on people's inflation expectations, and I think more
people probably look at that than of the CPI. It certainly influences
what workers demand, but it does not necessarily influence what
they are given. There are two factors in the labour market really.
One is that the increasing importance of bonuses and discretionary
pay additions means that the pay round is less important than
it used to be, and the second is that, as Mervyn was saying, we
cannot yet see a big increase in the level of settlements this
year. So so far, so good. The big news, I think, in the labour
market on the wage front, for me (and perhaps this is just from
my past interest) has been the very tight grip taken on the Public
Sector Review Body settlements, which was tough by anyone's standards
and I think also has some feedthrough into the likely future fiscal
path.
Q73 Chairman: Has it been a temporary
phenomenon? What is your view?
Sir John Gieve: I am expecting
all the price indices to fall when the gas price cuts come through
later in the year. The gap between the CPI and RPI varies from
time to time, depending on mortgages and council tax, and I have
not got it in my mind how far it will narrow or widen in the next
year.
Q74 Chairman: RACHAEL, is that good
news for my constituents at my surgery on Friday, that gas bills
are going to come down and the Deputy Governor of the Bank of
England tells us that?
Ms Lomax: I think they certainly
should come down, should they not? Wholesale gas prices have come
right down, so there is no reason why retail gas prices should
not follow them. There is not a lot to add to what my colleagues
have just said, except of course that one reason why the RPI is
as high as it is is because we have been putting up interest rates.
Q75 Chairman: You took account of
it in your deliberations?
Ms Lomax: No, it is an unavoidable
consequence and that is why we never use the RPI as a target variable
because it has this perverse property that, when you put up interest
rates to bring inflation down, the RPI itself rises. So, providing
we do not go on raising interest rates, that will sooner or later
work its way through.
Dr Sentance: I would expect the
recent rise in RPI inflation to be temporary and for it to come
down as inflation comes back to target. I think the issue which
is reflected in the Inflation Report discussion is that there
is quite a bit of uncertainty about that path of inflation and
how quickly it will come back to target. I think that has a bearing
on the secondary issue about how this might feed through into
pay settlements and obviously the longer the measure of inflation
continues at a high level, the greater is the risk that it will
feed through into pay. But there are factors that we have talked
about, gas and electricity prices, which cause us to be hopeful
that inflation will come down reasonably quickly over the first
half of this year, and we will need to monitor on a month-by-month
basis the extent to which that is coming through.
Q76 Chairman: Governor, in your speech
in Birmingham in January, you mentioned that the rise in CPI inflation
over the last year was not anticipated by the MPC a year ago.
In the light of your experience, have you taken any steps to improve
the monitoring of that?
Mr King: No, because, as I said,
a forecast is never a central projection; it is a set of probabilities
about various outcomes. It is always interesting to go back and
ask the question, "What were the things that occurred that
were not present in our central projection?", and there are
two main things to say about that. One was that we did not anticipate
the increases in gas and electricity prices that took place in
the second half of last year, it was not in the central projection
and perfectly reasonably so, and the second was that there were
other factors which clearly led to a pick-up of inflation that
we had not anticipated, and I tried in that speech to set out
arguments as to what those factors might be. It could be either
pressure of demand on capacity or a rise in inflation expectations,
but certainly one of the things we have seen in recent months
which we had not expected is the noticeable rise in the number
of firms who say they are now confident that they can make price
increases stick, and that is something that has been concerning
us. It is always very important to go back and ask the question,
"How did the world evolve in a way which was not in our central
projection?", but that is something that I would expect to
happen. The chance of the central projection materialising is
always, as I say at these hearings, close to zero and that is
very important. I deeply regret the fact that most forecasters
publish numbers for their forecasts as if they are bound to happen
when the chances of that happening are close to zero. It is a
fan chart or nothing, as far as I am concerned!
Q77 Chairman: I will finish on the
prospects of inflation and maybe ask everyone for a final comment
on that. Looking at the sensitivity of CPI forecasts in your Inflation
Report, how sensitive is the current CPI forecast to the assumed
future path of interest rates and what are the risks around that
assumption?
Dr Sentance: I think the forecast
we produced was on the expectation that was in the market at the
time of the Inflation Report, which suggested that interest rates
would go up a little bit further, and we showed that, if interest
rates were constant, the outlook for inflation would not be to
come down quite as closely to the target, but I think the risks
around that are probably the more significant thing. From my perspective,
as we have pointed out, we can see some factors that will mechanically
help to produce lower inflation in terms of energy prices, gas
and electricity prices. But of course we need to think about what
are going to be the pressures on the other prices in the basket,
and we have seen a pick-up in demand over the second half of last
year as well as the high price expectations the Governor has referred
to. So there is a risk that those factors could keep us above
target perhaps for longer than the central forecast is suggesting.
I voted for an interest rate rise in February, not in the March
meeting, but in February partly because I was concerned about
that risk and that is a risk that I am particularly focusing on.
Ms Lomax: The big debate really
over the last few months has been the extent to which the pick-up
in inflation has been reflecting supply shocks, like the gas and
electricity prices we have been talking about or the underlying
pressure of demand on capacity, and I think we have all had slightly
different views on that. I think the next six to nine months is
going to be really interesting in throwing light on that issue,
so in a sense what happens to inflation after that, for me, will
depend slightly on what the inflation outturn over the next six
to nine months is. I may have been wrong, in which case I will
change my mind, but, on the other hand, maybe inflation will turn
out quite a bit lower than we are predicting in the Inflation
Report. What one feels about inflation in two years' time is path-dependent,
in that sense. As for how sensitive is the inflation outlook to
interest rates, I think it depends on what happens to the exchange
rate. A lot of the transmission mechanism is through the exchange
rate and it is always quite difficult to call that. If the exchange
rate has not moved, then interest rates can have surprisingly
little effect certainly in our model and, if the exchange rate
does move, they can be much more powerful. So in terms of the
conditioning assumptions in the forecast: well people can get
very excited about the odd 0.25%, but I would not read an awful
lot into that as a statement of intent about where interest rates
are going.
Ms Barker: We discussed it at
length of course in the Inflation Report, as we always do, all
those various risks around the path to inflation, but I think
one fundamental, obvious point really is we talked about the fact
that certainly in the business sector, and noticeably the manufacturing
sector, price expectations at the moment are relatively strong.
Certainly if you talk to companies, they are more inclined to
say they are able to pass cost pressures on, and that has not
been my experience most of the time while I have been on the Committee.
But of course what is very difficult to tell is whether this is
a temporary or permanent state of affairs because ultimately prices
in these markets, as we have said, and in many other markets will
be set by demand and supply, so we are sort of back to the uncertainties
we all expressed earlier around exactly where the output gap is.
It is a different way of saying, that I agree with RACHAEL, that
we are not going to find out in the next couple of months exactly
where the balance lies and all we can do is look at all the indicators
we have and take our best view. My own view is that probably the
output gap is, as a lot of people have said, roughly around trend,
but there is an enormous amount of uncertainty and perhaps more
uncertainty than typical.
Sir John Gieve: I have not a lot
to add to that. I think I was with the majority in thinking that
the risks to our inflation projection were slightly on the downside
in the short term, but on the upside at the sort of two-year horizon.
What are the risks to that and the risks I am worried about? I
suppose there are two on the upside. One is that consumption growth
will be stronger than we have expected, and that will be an upside
pressure on the demand side. The second is the point that Kate
made about expectations not so much among wage-demanders, but
among price-setters among companies. Now, there is a sense that
there is a little bit more pricing power in the market now and
I will be watching to see whether that comes through in the next
few months.
Q78 Chairman: Governor, RACHAEL has
offered us the prospect of a tasty six to nine months. You had
the first word, but do you want the last one?
Mr King: There is only one extra
point I would make to your Committee which is that it is quite
tempting to try and forecast inflation by simply adding on what
we know is going to happen to gas and electricity prices, and
that is a mistake. What happens to other prices is not independent
of what is happening to gas and electricity prices. These big
changes in relative prices do affect the short-term dynamics of
inflation overall, that is true, but in the medium term they do
not, and I think the big challenge for us, and what is so difficult
is to know, is exactly how far the big movements in energy prices
that we have seen, both up and now down at the retail level, actually
influence the way in which firms set the prices for other goods
and services. It is very hard to know how to judge that and that
is why the next six to nine months will be very interesting and
very important for monetary policy. Our job is to ensure that
month by month we all keep taking decisions on interest rates,
to keep our judgment as to where inflation is likely to settle,
looking two years or so ahead, at the target, and that is what
we will commit to do.
Q79 Chairman: Governor, can I thank
you and your colleagues for your appearance this morning; it is
very helpful to us. We are mindful that you are coming back in
April for our inquiry into the MPC ten years on.
Mr King: Yes, and we look forward
to that.
Chairman: We are grateful, we thank you
for the written evidence to date and we look forward to our April
meeting. Thank you very much.
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