Bank of England May 2011 Inflation Report - Treasury Contents

Report to the Treasury Select Committee from Professor David Miles, External Member, Monetary Policy Committee, Bank of England


In the last year I have voted to maintain the size of the Bank's asset purchases at £200 billion and hold Bank Rate at 0.5%.

Output growth remained weak during the past 12 months, while inflation rose considerably above target. This left MPC members with a difficult choice. Tighter monetary policy could bring inflation back to target more quickly. But it would also prolong the period of weak economic growth. This would worsen the long-term impact of the financial crisis. It might also mean that monetary policy changes would need to be sharply reversed further ahead.

The remit of the MPC gives it the task of judging the appropriate policy to bring inflation back to target aftershocks have driven it off course. I consistently voted for keeping Bank Rate unchanged. The main reason is that the drivers of higher inflation are likely to be having a temporary impact. The increase in VAT, higher energy prices, and higher import prices account for more than 100% of the inflation overshoot. In contrast, underlying domestically generated inflationary pressures remain weak. Although there is very likely to have been a reduction in the supply potential of the UK economy, the scale of the decline in the level of GDP since the banking crisis suggests that there is significant spare capacity. Wage pressures have been subdued, with settlements running at around 2% despite a rise in household's near-term inflation expectations. The MPC's central forecast, which I believe is plausible, is that inflation will return to close to target by the end of next year.

Another reason for keeping Bank Rate at an exceptionally low level is that the spreads between Bank Rate and the rates that banks charge when lending to households and firms remains substantially higher than before the recession. For example, the spreads between unsecured lending rates and Bank Rate have widened, depending on the type of loan, by six to ten percentage points. Spreads between mortgage rates and Bank Rate have increased by about two percentage points. Put differently, some bank lending rates are now at a level that, ahead of the crisis, would have been consistent with Bank Rate being several percentage points above its current level of 0.5%. The monetary policy stance is not as loose as the current level of Bank Rate might suggest.

These spreads remained wide as banks' own funding costs increased as investors re-assessed risk. Banks have also re-assessed the risks associated with certain types of lending. They may also have attempted to generate higher profits to repair their balance sheets. In my view, this illustrates that an insufficient level of bank capital contributed to the depth of the recession and continues to delay the recovery.

Over the past year I have voted to keep the size of the Bank's asset purchases constant. During the recession, asset purchases are likely to have eased credit conditions. They also provided insurance against the downside risks to growth and inflation from constrained credit supply. In some respects these risks have diminished: measures of bank and corporate leverage have fallen, and output growth has picked up from 2009. However, risks remain. Further asset purchases may be warranted at some point in the future.


Both the financial and non-financial sectors are making steady progress in reducing their leverage. However, concerns in sovereign debt markets focusing on the sustainability of fiscal policies in some European countries may lead to a further tightening in credit conditions. Economic developments in the euro area are particularly important for the UK given its importance as an export market.

In the UK, net lending to individuals and non-financial companies has remained weak. A renewed tightening in credit conditions could inhibit the growth of private sector demand. If so, the degree of spare capacity in the economy would continue to push down on prices in the medium term and CPI inflation might then fall back below the MPC's target.

None of this means that I am comfortable with the current high rate of inflation. Far from it. We continue to face the problem of balancing risks: risks that inflation above target lasts long enough to become ingrained in expectations and affect behaviour so that it is hard to bring down, versus risks that the recovery in output becomes weaker and then disappears, leaving inflation pressures lower than is consistent with the target further ahead.

There is a clear risk that a protracted period of high CPI inflation could lead to higher inflation expectations becoming entrenched. Private-sector longer-term inflation expectations have increased according to some measures, though appear stable according to others. There is little evidence that any rise in inflation expectations has led to higher wage growth. Without a pickup in wage inflation I do not think it likely that inflation being significantly above target is sustainable. Of course wage pressures may build significantly over the next year, though I do not believe this is the most likely outcome. Risks of an extended period of low growth—which would further weaken those pressures—are also real.


In the 11 months since I last presented my annual report, I have made several visits to areas outside of London, including the Southeast & East Anglia, West Midlands, North East, Central Southern England and the East Midlands. On these visits I have spoken to many companies—large and small—and learnt a great deal about price pressures and about how monetary policy might affect firms in various sectors.

To communicate my views on monetary policy more widely I have given several interviews (to BBC Radio Sussex, Derby Telegraph, East Anglian Daily Times, Eastern Daily Press, The Financial Times, Northern Echo, and Stoke Sentinel).

I have also spoken at a number of schools and universities to explain how monetary policy in the UK is being set.

I have given four on-the-record speeches, all of which focused on the link between the financial sector and monetary policy. I also published a Discussion Paper on the optimal level of bank capital.

June 2011

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© Parliamentary copyright 2011
Prepared 21 September 2011