Select Committee on Treasury Written Evidence


Memorandum submitted by Bridget Rosewell, Volterra Consulting

  Economic growth seems robust and the concerns voiced at the beginning of this year that 2006 would experience weak consumer growth appear to have been misplaced. Growth of output in London increased to a rapid 3.4% in the second quarter of 2006, well above the rate for the UK as a whole. London is particularly responsive to changes in the fortunes of the financial services sector and the expected size of this Christmas' City bonuses suggests that the sector is performing well. Financial services employment in London is likely to have risen in 2006 after three consecutive years of employment loss.

INTERNATIONAL RATES

  After five years in which the UK repo rate has been above that of the US, US rates moved above UK ones at the beginning of the year. The recent moves bring UK rates closer in line with those in the US and also widen the gap with Euro rates again, which had also sharply narrowed.

  It would be useful to discuss the view taken in the MPC of appropriate margins with other international base rates. The Inflation Report does not discuss this.

INFLATION COMPONENTS

  Falling energy prices over the last quarter should feed through to utility bills if the falls are sustained. However, at the very least there is a considerable lag effect. Recent work undertaken by "Which?" Research suggests that gas bills are now typically 60% higher than a year ago and electricity bills 40% higher. This takes the average annual household expenditure on gas and electricity to £1,030, up more than £350 on 2005. As well as having an effect on overall inflation, such an increase will have significant distributional impacts. Many utility companies are still announcing increases due to take effect in the New Year.

  It is widely accepted that the Retail Price Index (RPI) measure is more commonly used in wage negotiations and this measure is now at its highest level for more than eight years (3.7%). This might mean that wage settlements in the 2007 pay round could be driven significantly higher. However, the trend in the Average Earnings Index is currently downwards. Even including bonuses, the growth on one year previously dipped back beneath 4% in September (the latest data available). It is worth bearing in mind that bonuses tend to be concentrated in specific, higher-level occupations within the financial sector and therefore are likely to have their greatest impact in London.

  The Bank discusses these effects and the role of inflation expectations in pages 29-32.  What is not clear from this is what evidence they would consider would definitely show that inflation expectations had risen unduly or were now more embedded and likely to drive inflation further up.

SPARE CAPACITY

  The Governor has said that it has become increasingly difficult to judge the state of spare capacity in the economy. Their own surveys suggest that capacity utilisation is well above its historic norm, while sluggish wage pressure suggests room for manoeuvre. It may also be that the concept of spare capacity has become much more slippery. With more and more activity in the service sector it is the flexibility of the workforce which drives the ability to expand, as well as the ability to increase hours or recruit. Availability of fixed rather than human capital is much less relevant. Yet we have almost no measures of human capital in its application to output. This is issue is further complication by ignorance about the levels of immigration. Some estimates suggest that this may be running at twice the official levels.

  In my view, judging the scope of the economy to grow has always been an uncertain matter—perhaps it has become less certain.

  This may well lie behind the apparent widening of the uncertainty band in the GDP projection. It would be worth exploring this further with the Bank.

November 2006





 
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