Report to Treasury Select Committee Kate Barker External member, Monetary Policy Committee June 2008 Promoting transparency and understanding of monetary policy Over the year to June 30 2008, relevant activities have been: • On-the-record speeches: Financial instability and UK monetary policy (October 2007). This concluded (based on past performance) that business surveys would provide useful early warnings on downside risks from the evolving credit crunch. Policy dilemmas (February 2008). This stressed that changes in risks, rather than just changes to central projections, were likely to drive policy decisions in 2008. I expressed particular concern about downside risks from the ongoing volatility in credit markets1. Regional visits. I carried out seven regional visits, and participated in the Court/MPC visit to Northern Ireland. These trips involved 23 company visits (across a range of sectors and firm size), eleven discussions with business groups, and four Inflation Report briefings. In addition, they included eleven interviews with local news media. • I have given talks about monetary policy at a range of other events, including two schools. Reasons for MPC votes over the past year I voted for the 0.25 point rise in Bank Rate last July, and for the subsequent three 0.25 point cuts. Over the past year I have voted in line with the majority position. In July and August 2007, the MPC faced an economy with evidence of growing capacity pressures, robust credit growth and business surveys indicating rising shortterm upward price pressures due primarily to imported inflation. These factors suggested that the then robust pace of growth in the economy needed to slow in order to keep inflation on target. It was unclear that the four 0.25 point Bank Rate increases since August 2006 would prove sufficient to achieve this, although given the lags before the full response to policy changes, there was concern about policy being overaggressive. In my view this did not outweigh the increasing evidence that inflation pressures were proving stronger than expected, justifying the additional July 0.25 point rise in Bank Rate. After the financial market turmoil began in August 2007, the key issues then became the nature and duration of the credit tightening, and its likely impact on business and consumer sectors. Nevertheless, the UK economy overall grew as strongly in the second half of 2007 as the MPC had expected in the August Inflation Report, suggesting that there had been more momentum in the economy than we had believed. Absent the financial market events, I believe Bank Rate would have had to rise in autumn 2007.
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Full texts at: http://www.bankofengland.co.uk/publications/speeches/speaker.htm#barker
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With financial market conditions remaining fragile, downside risks to inflation from weaker growth were emerging during the autumn. I judged that this concern, exacerbated by uncertainties about the potential scale of bank write-downs, dominated worries about higher inflation from rising oil prices. Consequently I voted for 0.25 point Bank Rate cuts in December and February. During February and March, money markets were further impaired. Despite continuing resilience in official data, survey data was weakening, particularly for the housing market. Although upside inflation risks were also apparent, I again put more weight on the worsening downside in supporting the 0.25 point April Bank Rate cut. Financial market conditions have recently eased slightly, partly due to the introduction of the Special Liquidity Scheme, although the adverse impact of the credit crunch has become more apparent with sharp deterioration in the housing market. However, with global demand remaining robust overall, and oil and food price rises pushing up public inflation expectations, the upside risks to inflation over the medium-term have also worsened. In May and June, I judged it appropriate to leave Bank Rate unchanged. The inflation outlook and risks Higher energy and food prices have taken CPI inflation to 3.3% in May. The impact of recent further rises in oil prices and wholesale gas futures is expected to push CPI inflation considerably higher in the short term. But with energy price volatility likely to continue, the CPI outlook is also highly uncertain. Both the public’s short-term inflation expectations, and inflation expectations derived from financial markets, have risen. The large and prolonged shock to inflation from higher oil and food prices risks reducing credibility in the MPC’s ability to deliver the inflation target over the next 23 years. Inflation expectations may well fall back if, as expected, the impact on inflation from energy and food prices wanes over 2009. But should the period of above-target inflation result in a more long-lasting loss of credibility, it could prove costly to return CPI inflation to 2%. A period in which there is spare capacity in the economy is necessary to ensure higher inflation does not become embedded. In judging the appropriate rate of growth, it is relevant that the UK’s supply potential may slow a little, due to the adverse impact of tighter credit on investment and a possible slowing in net inward migration. Also, the prospect of sustained higher import price inflation due to stronger global price pressures means that domesticallygenerated inflation may need to be less than in recent years. The latest evidence clearly suggests that growth is now slowing, although it is not easy to judge the extent, due to differing fortunes across sectors. While the financial and construction sectors have been hard-hit, manufacturing and particularly exporters, supported by the depreciation of sterling, are faring better. There will be difficult judgements in seeking to balance appropriately the upside risks to inflation of a more significant loss of credibility in the inflation target, against the downside risks from
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increased pressure on the financial sector due in particular to declining property prices, and from the marked squeeze on real household incomes. Over the next few months the path of inflation is likely to be dominated by energy price developments. But it is changes in pricing behaviour and in wage growth (until now relatively subdued) which will indicate whether the medium-term upside risk to inflation is materialising. Conditions in financial markets, together with developments in property markets, employment and consumer spending, will be key to monitoring downside risks to growth that would tend to reduce future inflation. I consider that the appropriate path of interest rates over the rest of this year remains highly uncertain.
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