INFLATION REPORT PRESS CONFERENCE Wednesday 14 November 2007 Opening Remarks by the Governor Since the August Inflation Report, the economic news has been dominated by developments in world financial markets. These have their origins in the state of the world economy. And it is the world economy that shapes the MPC’s latest projections. Serious weakness in the US housing market was the trigger for the financial turmoil and tightening of credit conditions that is now underway. But strong growth in Asia, together with limitations on supply, have helped to push up further commodity prices in general and oil prices in particular. The result is that the central outlook for the UK economy in today’s Report is, in the near term, one of slowing growth and rising inflation. But, further ahead, that outlook is for a return of growth to its average rate and inflation to the target. In August, the Committee judged that movements in retail gas and electricity prices would lead inflation to fall back to close to the target in the near term. But the Committee also judged that some slowing of the pace of output growth was necessary to meet the 2% inflation target in the medium term. Inflation has fallen back to around the target. And although output growth is estimated by the ONS to have remained robust, surveys do now suggest that growth has started to ease. The turmoil in global financial markets has led to a rise in risk premia. As a result, there has been some tightening in the supply of credit to both companies and households. The extent of any further tightening and its impact on demand are key areas of uncertainty. Surveys suggest that business investment intentions have fallen somewhat, but remain above their long-run average. With house price inflation easing and commercial property prices falling, residential and commercial property investment are likely to moderate, possibly quite sharply. And with tighter credit conditions in the future, the personal saving rate is likely to rise, bearing down on consumer spending. 2 The Committee’s latest projection for GDP growth is shown in Chart 1 (GREEN CHART) on page 7 of today’s Report. The fan chart combines for the first time the MPC’s judgment about the degree of uncertainty associated with the forecast for future growth and that associated with the ‘backcast’ of past growth. The backcast takes into account the historical pattern of revisions to official data and the information contained in business surveys, as foreshadowed in the August Report and explained in detail in Charlie Bean’s speech on 31 October. The Committee judges that official estimates of output growth over the recent past are more likely to be revised up than down, though the margin of uncertainty is wide. The projection shown in Chart 1 (GREEN CHART) is based on the assumption that Bank Rate moves in line with market expectations over the forecast period. Since August, there has been a considerable reduction in the path of Bank Rate implied by market yields and the sterling exchange rate has fallen. Notwithstanding those changes, the central projection is for growth to slow sharply over the next year as past rises in Bank Rate and tighter credit conditions push up rates of private saving and push down rates of investment. Further ahead, the central projection is for output growth to recover to close to its long-run average rate but, in the Committee’s judgment, the balance of risks is on the downside. In August the Committee identified an upside risk to the inflation outlook from global commodity prices. Since then, both world oil and food prices have risen by more than 10% and UK wholesale gas prices for the coming year have risen by around 20%. These developments will hold back the growth rate of real incomes and moderate consumer spending. But they will also hinder the ability of the economy to expand without pushing up inflation. The Committee’s projection for CPI inflation is shown in Chart 2 (RED CHART) on page 8 of the Report, again on the assumption that official interest rates follow market expectations. In the central projection, pressures on capacity and the renewed rise in 3 energy prices push inflation up in the near term. But after a period of slower growth, with capacity pressures abating, inflation falls back to settle around the 2% target. In the Committee’s judgment, the risks to inflation are broadly balanced. Further tightening of credit conditions and disturbances in financial markets pose the biggest downside risk to the outlook. But, in contrast to the picture of stable pay growth painted by the average earnings index, the average weekly earnings index points to growing pay pressures. And surveys of inflation expectations have not fallen back as inflation has returned to the target. These developments, and the possibility that energy and commodity prices continue to rise, pose upside risks to the central projection. The Committee judges that the degree of uncertainty about the outlook is greater than in August and will be monitoring the risks closely. Timely surveys of spending and investment, the price and quantity of credit and asset prices will be used to monitor the projected slowdown in domestic demand. Indicators of domestic demand in the US and Asia will reveal whether the world economy is slowing as the rebalancing that is now clearly underway evolves. And commodity prices, surveys of household inflation expectations and the full range of pay and earnings measures will be used to assess the upside risks to inflation. In comparison with August, the near-term outlook is less benign for both inflation and growth. Last week, the Committee judged that it was appropriate to leave Bank Rate unchanged. There will be some difficult decisions in the months ahead. But the MPC remains focussed on meeting the 2% inflation target in the medium term.
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