Report to Treasury Select Committee from
Charles Bean, Deputy Governor for monetary policy
VOTING RECORD
My previous report, in February 2010, was written
just as the ONS produced its first estimate for GDP in 2009 Q4,
showing growth of just 0.1% (subsequently revised up to 0.5%),
the first quarter of expansion after six quarters of contraction.
At that point, the MPC had lowered Bank Rate to 0.5% and purchased
£200 billion of assets financed through the issuance of central
bank reserves, moves which I had fully supported. In the associated
Inflation Report, the Committee's projection under market
interest rates - to which I subscribed - was for mean growth to
recover to around the UK's historical average rate during 2010
and to continue thereafter at a little above that rate. CPI inflation
was projected to reach 3.4% in 2010 Q1, but then to fall back,
dipping below the target, as the downward force from persistent
spare capacity outweighed the waning influence of the pass-through
from the depreciation of sterling in 2007-8 and the restoration
of the standard rate of VAT to 17.5%.
A year ago, the strength and durability of the recovery
was unclear and considerable downside risks remained. For me,
the question then was whether further asset purchases would be
needed or not, and whether their effectiveness as a monetary tool
might decline, the more purchases we made. At that juncture, I
thought it best to pause to take stock of the strength of the
recovery and to assess the impact of the monetary actions that
we had already taken.
As the year progressed, so the recovery seemed to
be gaining a firmer footing much as I expected, at least until
the snow-affected fall in activity in 2010 Q4. Offsetting that,
however, I became increasingly concerned about the potential for
sovereign debt problems in several euro-area periphery countries
to lead to a new bout of financial market turbulence, denting
the recovery and depressing inflation in the medium term.
While growth has been roughly in line with expectations,
CPI inflation has been markedly higher than I expected back in
February 2010. That reflects two primary factors. First, we appear
to have significantly under-estimated the degree of pass-through
from sterling's 2007-08 depreciation, incorrectly assuming that
it would be broadly similar to that seen after the exit of sterling
from the ERM in 1992. Second, commodity prices, and global prices
more generally, have been markedly higher than expected by either
us or market participants, reflecting both adverse supply factors
and robust growth in emerging economies. In addition, the downward
force from spare capacity appears to have been less than I originally
judged and, of course, the further increase in VAT to 20% has
more recently resulted in an additional rise in the price level.
From a policy perspective, what matters is inflation
in the medium term - there is little we can do about inflation
in the near term - and I have concurred with the consensus on
the Committee that the influence of the factors presently boosting
inflation should prove temporary: the influence of the 2007-08
depreciation of sterling should be nearly complete by now; commodity
prices are unlikely to continue rising at such a rapid rate; and
the increase in VAT is unlikely to be repeated in 2012. Accordingly,
given the fragility of the recovery, I have judged it appropriate
to vote to maintain the existing stance of monetary policy at
all MPC meetings over the past year. But I have become rather
more concerned that the period of elevated inflation may persist
for somewhat longer than I originally thought, and for me the
balance of risks to inflation around the target has been shifting
upwards in recent months.
THE OUTLOOK
I expect growth to resume in 2011 Q1, but underlying
growth across 2010 Q4/2011 Q1 together looks likely to be weak.
What is presently unclear is whether this represents a temporary
soft patch of the sort that is often seen during recoveries, or
whether it represents a more durable slowing in the rate of expansion
as the joint headwinds of fiscal consolidation and the squeeze
on living standards from the deterioration in the terms of trade
hit home. That is something we should learn more about in the
coming months.
Inflation is set to remain well above the target,
most probably in the 4-5% range, for much of this year. There
may be some respite from commodity price inflation as supply conditions
in agricultural markets improve, but a reversal of last year's
price rises is only likely if global growth were to slow sharply.
And continued robust growth in emerging economies may result in
further upward global price pressures, though their contribution
to inflation here is likely to diminish as 2011 proceeds. I still
expect inflation to drop back as we go into 2012 and this year's
increase in VAT drops out of the 12-month comparison, though a
rebuilding of profit margins and some second-round effects on
pay growth may help to keep inflation a little elevated above
the target next year. But the period of substantially elevated
inflation cannot persist indefinitely unless either the external
shocks are repeated or a rise in inflation expectations leads
to durably higher pay growth and a wage-price "loop".
At this stage, that does not appear to be happening, though I
shall be watching the relevant indicators carefully in the coming
months.
EXPLAINING MONETARY
POLICY
Since my previous report in February 2010, I have
given four on-the-record speeches on monetary policy issues, together
with numerous off-the-record presentations to a variety of audiences.
I made five regional visits (to Birmingham/Coventry, Southampton,
Kent, Merseyside/Cheshire and Wales) involving various meetings
and events with local business people. I also attended a variety
of events with journalists, City economists and market participants.
Finally, as Deputy Governor for Monetary Policy, I also represent
the Bank's views in a number of international settings, including
the G7, G20, and the OECD.
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