Bank of England

1

• Bank of England
• Monetary Policy and Outlook
• 25 April 2005

2
Short Quiz

• What is the trend annual growth rate for the UK
  economy?
• What is the current annual growth rate for the UK
  economy?

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The Economic Cycle
GDP
Inflation pressures
GDP
Growth trend
Unemployment worries
Time
4
Our Objective

• to deliver price stability
• (as defined by the Governments inflation target)
• and, subject to this objective,
• to support the Governments economic policy,
• including its objectives for
• growth and employment

Bank of England Act 1998
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Why is high inflation a bad thing?

• High inflation associated with instability
• Inflation creates many distortions in a market
  economy, which harms its performance.

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Short Quiz

• What is current inflation target?
• What is current inflation rate?

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A symmetric target

• A government inflation target expressed in terms
  of RPIX (2.5 or below) was first adopted in 1992
• May 1997 December 2003, a symmetric RPIX
  inflation target of 2.5.
• From January 2004 a symmetric 2.0 target for
  consumer prices inflation (CPI).

8
MPC what is it?

• Established in May 1997 to establish the policy
  interest rate
• Government no longer has any direct say on
  interest rates but sets the inflation target
• 9 members including 4 external recognised
  experts
• Replaces monthly meetings between Chacellor and
  Bank Governor

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More questions

• What does the MPC control directly
• Rate at which banks borrow from Bank?
• Rate on home loans?
• Rate on credit cards?
• Exchange rate?

10
Process

• Monthly meetings - fixed timetable, though one
  emergency meeting on 18 Sep 2001.
• Pre-MPC Friday before MPC meeting
• MPC meeting over 2 days decision at 12 midday on
  second day
• Minutes of meeting published two weeks later

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A quarterly cycle

• A forecast
• Not a point estimate. Too much focus on the
  central projection.

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How long does it take for change in interest
rates to have maximum effect on inflation?

• Less than 1 month?
• Between 1-3 months
• Between 3-6 months?
• Between 6-12 months?
• between 12-24 months?
• Longer than 24 months?

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Time Lags
Rate change
Inflation
Financial Markets Expectations
Demand Output
6-12 months
Time 0
12-24 months
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Economic Outlook
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Current CPI inflation projection based on market
interest rate expectations
The fan chart depicts the probability of various
outcomes for CPI inflation in the future. If
economic circumstances identical to todays were
to prevail on 100 occasions, the MPCs best
collective judgement is that inflation over the
subsequent three years would lie within the
darkest central band on only 10 of those
occasions. The fan chart is constructed so that
outturns of inflation are also expected to lie
within each pair of the lighter red areas on 10
occasions. Consequently, inflation is expected
to lie somewhere within the entire fan chart on
90 out of 100 occasions. The bands widen as the
time horizon is extended, indicating the
increasing uncertainty about outcomes. See the
box on pages 4849 of the May 2002 Inflation
Report for a fuller description of the fan chart
and what it represents. The dotted line is drawn
at the two-year point.
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• The only function of economic forecasting is to
  make astrology look respectable J. K.
  Galbraith      

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Current GDP projection based on market interest
rate expectations
The fan chart depicts the probability of various
outcomes for GDP growth in the future. If
economic circumstances identical to todays were
to prevail on 100 occasions, the MPCs best
collective judgement is that GDP growth over the
subsequent three years would lie within the
darkest central band on only 10 of those
occasions. The fan chart is constructed so that
outturns of GDP growth are also expected to lie
within each pair of the lighter green areas on 10
occasions. Consequently, GDP growth is expected
to lie somewhere within the entire fan chart on
90 out of 100 occasions. The bands widen as the
time horizon is extended, indicating the
increasing uncertainty about outcomes. See the
box on pages 4849 of the May 2002 Inflation
Report for a fuller description of the fan chart
and what it represents. The dotted line is drawn
at the two-year point.
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• The world
• The UK economy
• picking up momentum
• BUT
• link between activity and inflation unusually weak

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US GDP Growth

• GDP growth was unrevised in Q4, at 0.9 oqa.

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US Current Account

• The US current account deficit increased to 6.3
  of GDP in Q4

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US Dollar ERI
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Brent Crude Oil Price
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Euro-area GDP Growth

• Euro-area growth slowed during 2004.

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Japanese GDP
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World Semiconductor Sales
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The world

• US recovery continues
• Euro area weak but improving
• Japan slowly returning to trend growth
• China expanding rapidly
• World growth set to moderate in 2005, but still
  fairly strong

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UK GDP at market prices
Percentage changes
5.0
4.5
Latest quarter on a year earlier
4.0
2.9 0.7
3.5
3.0
2.5
2.0
1.5
Latest quarter on previous quarter
1.0
0.5
0.0
2000
2001
2002
2003
2004

• GDP growth at market prices unrevised in Q4

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Business investment
(a) Chained volume measure.
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Consumer spending
31
Consumption
Contribution to quarterly consumption growth (pp)
Retail goods
Energy
1.6
Services
Net tourism
Vehicles
1.2
0.8
0.4
0.0
-0.4
-0.8
2002
2003
2004

• Q4 outturn driven by weaker retail goods
  consumption

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Retail sales
Percentage changes
4.0
Latest 3 months on
3.0
previous 3 months
2.0
Feb 0.2 -0.6
1.0
0.0
-1.0
-2.0
Month on
previous month
-3.0
-4.0
2002
2003
2004
2005

• Small amount of downside news in retail sales
  release on
• account of back revisions

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Housing transactions and retail goods
Thousands
Percentage change on previous year
10
500
8
450
Retail goods (rhs)
6
400
4
350
2
300
Transactions (lhs)
0
250
-2
200
1990
1992
1994
1996
1998
2000
2002
2004
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Households real post-tax income
Percentage change on previous quarter
3.0
2.5
2.0
1.5
1.0
0.3
0.5
0.0
-0.5
-1.0
2000
2001
2002
2003
2004
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Contributions to service sector growth
Contribution to quarterly service sector growth
(pp)
1.5
Transport and communication
Total
Business services and finance
1.0
0.5
0.0
Distribution, hotels and catering
Government and other
-0.5
2000
2001
2002
2003
2004
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Net trade
Contribution to quarterly GDP growth (pp)
1.5
1.0
New
0.5
0.0
-0.2
-0.5
-1.0
2000
2001
2002
2003
2004
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4.7
2.6
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Wage settlements by sector Three month AEI
weighted means
Per cent
6
5
Public sector
3.5
4
3.4
3
Whole
3.1
Private sector
2
economy
1
1997
1998
1999
2000
2001
2002
2003
2004
2005
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Matched settlements
January -February 2005
Matched sample
Last year
This year
Production
3.9
3.9
Construction
6.3
4.9
Private services
3.0
3.1
Public
3.8
3.1
Whole economy
4.8
4.2
AEI weighted whole economy
3.4
3.2
40
Regular pay and average hours Three-month
averages, change on a year earlier
Per cent
8
6
Per head 4.4
4
Per hour 3.1
2
0
-2
Average hours
growth
-4
2000
2001
2002
2003
2004
2005
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Overall average earnings growth Three month
average, annual rate
Per cent
12
10
8
Private
4.6
6
Whole economy
4.4
4
4.4
2
Public
0
1990
1993
1996
1999
2002
2005
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Manufacturing input prices
Per cent
15
10.8
10
Input prices
6.5
5
0
-5
Input prices
excl oil
-10
-15
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
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Import prices/domestic output prices
Index 1998 100
110
Consumer goods
105
100
95
Capital goods
90
Intermediate goods
85
80
1998
1999
2000
2001
2002
2003
2004
2005

• Relative price of imports has declined in all
  categories since 2001

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Activity inflation

• Unemployment at 30-year low
• BUT wage growth broadly stable
• Factory gate inflation at 10-year high
• BUT retail goods prices flat or falling

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UK imports from developed countries (a)
(a) Proxied by Canada, the euro area, Japan and
the United States. (b) In current prices. It
includes intermediate goods and finished goods.
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Retail sector productivity
Defined as whole-economy output less government
and other services divided by a Workforce Jobs
measure of employees adjusted to be on a calendar
quarter basis.
48
Current CPI inflation projection based on market
interest rate expectations
The fan chart depicts the probability of various
outcomes for CPI inflation in the future. If
economic circumstances identical to todays were
to prevail on 100 occasions, the MPCs best
collective judgement is that inflation over the
subsequent three years would lie within the
darkest central band on only 10 of those
occasions. The fan chart is constructed so that
outturns of inflation are also expected to lie
within each pair of the lighter red areas on 10
occasions. Consequently, inflation is expected
to lie somewhere within the entire fan chart on
90 out of 100 occasions. The bands widen as the
time horizon is extended, indicating the
increasing uncertainty about outcomes. See the
box on pages 4849 of the May 2002 Inflation
Report for a fuller description of the fan chart
and what it represents. The dotted line is drawn
at the two-year point.