Bank of England May 2011 Inflation Report - Treasury Contents

Report to the Treasury Select Committee from Spencer Dale, Chief Economist, Bank of England


My previous report to the Treasury Select Committee was in February 2010. Since then, I have voted at each meeting to maintain the stock of purchased assets at £200 billion. Until February 2011, I voted to maintain Bank Rate at 0.5%. Since February, I have voted to increase Bank Rate by 25 basis points to 0.75%.

Since the beginning of 2010, the economy is estimated to have recovered modestly from the deep recession. But growth around the end of last year slowed and that slower growth appears to have persisted into the first half of 2011. The level of output remains below its pre-crisis peak and the unemployment rate elevated. At the same time, inflation has been well above the 2% target. It seems likely that most of the strength in inflation over the past year or so has stemmed from a series of price level shocks, which should have only a temporary effect on inflation. As best we can measure them, domestic inflation pressures appear to remain relatively subdued. As such, the key task of monetary policy continues to be to support the recovery and bring the economy better into balance, thereby reducing the risk of inflation significantly undershooting the target in the medium term. Even with Bank Rate at 0.75%, monetary policy would remain highly stimulatory.

Since the time of my previous report, I have revised down my medium-term outlook for the level of GDP. On its own, this would have supported a further increase in the size of the asset purchase programme. But I have also revised down my view of the supply potential of the economy. Although highly uncertain, developments in productivity and employment over the past year suggest that the margin of spare capacity is probably lower than I previously thought. This downward revision, together with further increases in oil and other commodity prices and the rise in the standard rate of VAT to 20%, contributed to a significant deterioration in the outlook for CPI inflation.

In early 2011, I became increasingly worried about the upside risks to inflation, from both the possibility that global price pressures may continue to push up on inflation, and the possibility that the sustained period of above target inflation may start to cause some companies and households to question the Committee's competence or commitment to control inflation. Despite recognising the downside risks to the strength of the recovery, these concerns about the inflation outlook caused me to vote for an increase in Bank Rate to 0.75%.


My current view of the economic outlook is broadly in line with the projections for GDP and inflation contained in the May Inflation Report. I expect a continuing recovery in the global economy to support growth in the United Kingdom, alongside the considerable stimulus from monetary policy and the current level of sterling. But the persistent squeeze on households' real incomes is likely to weigh on demand, especially over the next year or so. CPI inflation looks set to rise further this year, before falling back through 2012 into 2013 as the impact of external price pressures and the increase in VAT dissipates and some downward pressure from a margin of spare capacity in our economy persists. Even so, CPI inflation is likely to remain above the 2% target for much of the next two years.

The economic recovery in the UK remains fragile; in particular, the continuing squeeze on households' purchasing power means there is a risk that consumer spending may weaken further. Given the fragility of the recovery there are merits to keeping Bank Rate on hold or even increasing the scale of asset purchases further. Maintaining the current stance of policy for longer (or moving to a more expansionary policy) would help to stimulate a stronger recovery and so reduce the risk of inflation falling below target in the medium-term. But I am also worried about the upside risks to inflation. CPI inflation has been above target for much of the past five years. There is a risk that this sustained period of above-target inflation will lead to further upward pressure on prices, either because some households and businesses come to expect elevated inflation to persist or if the squeeze on households' real incomes leads to higher pay growth. In addition, there is a risk that continued strong global growth, especially in emerging economies, may increase the upward pressure on import prices, particularly those of commodities. My judgement at the June MPC meeting was that these risks would have been best balanced by a small increase in Bank rate to 0.75%.

The extraordinarily low level of Bank Rate means that interest rates will have to rise at some point, but when and by how much is impossible to say. How the economy will evolve and thus how policy will need to respond cannot be known with any certainty. All we can do as policymakers is to remain open minded and to challenge our view of the economic outlook and of the appropriate stance of monetary policy each and every month. I will continue to approach my task on the MPC with considerable pragmatism, recognising the imperfect knowledge and understanding we have about both the state of the economy and the way it which it behaves.


Since February 2010, I have delivered four on-the-record speeches, given three interviews to national media, and made numerous off-the-record presentations to a variety of audiences. These included background briefings for market economists and economic journalists on the asset purchase programme. I have made six regional visits which involved various meetings and events with local businesses and media. As the Bank's Chief Economist, I have extensive liaison with economists in the private and official sectors, both in the UK and internationally.

July 2011

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Prepared 21 September 2011