Bank of England November 2009 Inflation Report - Treasury Contents

Report to the Treasury Select Committee from Mervyn King, Governor of the Bank of England


  The past year has been a painful one for the UK economy. Mirroring developments in other advanced economies, nominal spending, which normally grows at a rate close to 5%, has fallen sharply. It is now around 10 percentage points below its long-run trend. That is a measure of the monetary squeeze that the economy has experienced in the wake of the financial crisis last autumn. As a result, output has contracted sharply—by almost 6%—opening up a margin of spare capacity in the economy. And that is now being reflected in the labour market: unemployment has increased steeply, to its highest level since 1995.

  Partly in response to the sharp fall in spending, and the emerging margin of spare capacity, inflation has fallen from its peak of 5.2% to 1.5% in October. Notwithstanding a temporary pick-up in inflation over the next few months, spare capacity will continue to pull down on the outlook for inflation for some time to come. As a result, over the past year, the risks to the outlook for inflation in the medium term relative to the target have shifted markedly to the downside.

  In response to these developments, I voted, like the rest of the MPC, for sharp cuts in Bank Rate towards the end of last year and in the early part of this year. Bank Rate was cut from 5% to 0.5% in five months—the lowest level of official interest rates in the Bank's 315 year history. In March, when Bank Rate reached 0.5%, the Committee also chose to embark on an unprecedented programme of asset purchases to inject extra money directly into the economy to provide more stimulus. Financial market participants will use this money to diversify into other assets that have a higher return than holding cash. In turn that will push up the prices of these other assets, and so boost spending and the outlook for inflation. Initially, the MPC voted unanimously for a £75 billion programme of purchases, which in May was extended to £125 billion, again unanimously. In August, owing to continuing weakness in the outlook for inflation, I voted in a minority to extend the programme to £200 billion pounds. At the time, a majority of the MPC voted for it to be extended to only £175 billion. But in November, a majority of the MPC voted to extend the programme of asset purchases to £200 billion.


  In the short run, inflation is likely to rise sharply, reflecting temporary factors such as an increase in petrol price inflation and the reversal of last year's cut in VAT. But in the medium term, the margin of spare capacity, if it persists, will continue to drag down on the outlook for inflation.

  Several factors will boost demand in the economy looking ahead, and hence help to eliminate that margin of spare capacity. Most notably there is the very significant monetary policy stimulus. In addition, the depreciation of sterling—now around 25% lower than its peak in mid-2007—will encourage demand to switch towards UK-produced goods and services both at home and abroad. And in the short run, a turnaround in the stock cycle will also help to boost output.

  But set against these factors, there are also powerful forces that will act to restrain spending in the economy as a whole. First, banks are continuing to lower their leverage from extraordinary high levels. While this continues, the supply of credit to companies and households will be impeded. Second, households and companies are also likely to be cautious in their spending behaviour in the face of uncertain future incomes and profits. Third, there is a clear need for a credible plan to stabilise the public finances in the years ahead. And finally, the level of demand around the world, and hence demand for UK exports, is markedly lower than in the summer of 2008.

  Given all of these factors, at the November MPC meeting, I judged that, without further monetary policy stimulus, the risks to the outlook for inflation relative to the target would be to the downside. It was for that reason that I voted at the November meeting to increase our programme of asset purchases to £200 billion. And I stand ready to take whatever actions are necessary in the future to ensure that the outlook for inflation remains in line with the 2% target.


  Over the past year, I have given four on-the-record speeches about the economy and monetary policy. I have answered questions at four Inflation Report press conferences and made six parliamentary appearances before the Treasury and Economic Affairs Committees. Those appearances were all shown on television. I have also appeared on television on a number of other occasions—for example, I gave interviews when the asset purchase programme began in March. On average, I have made a televised appearance about once every three weeks.

  In addition, I have made eight visits to areas outside London—to Scotland, Northern Ireland, the North-East, North-West, East Midlands, South-West, South-East and Central Southern regions (including the Isle of Wight). The visits involved numerous company visits and meetings with business people, and have given me a valuable opportunity both to hear the views of those in the business community first-hand and to explain the decisions of the MPC. Those visits also gave me a good opportunity to explain our monetary policy actions via interviews or articles in the local press. In addition, I have given over 20 talks where I have had a further opportunity to explain monetary policy.

  Over the past year, I have also attended 14 sets of meetings abroad. Typically these are meetings of various different international bodies—the G7, G20, IMF and BIS—or at other central banks.

18 November 2009

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