Minutes of Monetary Policy committee meeting (2005-08-03)
mpc:
MINUTES OF THE MONETARY POLICY COMMITTEE MEETING HELD ON 3-4 AUGUST 2005
1
Before turning to its immediate policy decision, and against the background of its latest
projections for output and inflation, the Committee discussed developments in financial markets; the
international economy; money, credit, demand and output; and costs and prices.
mpc: 2
In the United Kingdom, short-term market interest rate expectations had changed little over the
past month, with a 0.25 percentage point rate cut priced in for this month's decision, a strong
expectation of a second rate cut later in the year and the possibility of a further reduction in early 2006.
In the latest Reuters poll, 43 out of 47 economists had expected a 0.25 percentage point reduction in
interest rates at the August meeting, and slightly under half of the sample expected at least one further
reduction this year. Financial markets had priced in a somewhat larger reduction in official interest
rates over the next year than expected by economists, although the difference appeared to have
narrowed somewhat in recent days.
mpc: 3
It was possible that the market expectation of more than one interest rate reduction was based on
extrapolations of past Committee voting patterns. Furthermore, some commentary on the UK
indicators seemed surprisingly gloomy and that may have affected market sentiment. It was important
not to attach too much weight to the market's central expectation; option prices suggested that market
participants attached weight to a range of possible outcomes. The implied probability of a fall in
interest rates had increased following the release of the Committee's July minutes. Long-term forward
interest rates were little changed on the month in either the United Kingdom or overseas. Credit
spreads had fallen slightly.
mpc: 4
The sterling effective exchange rate index (ERI) had depreciated by 1% over the month, and had
fallen by more than 3% since the May
Inflation Report. That was one of the largest changes in the
exchange rate between
Inflation Reports since the Committee's inception in 1997. The recent
depreciation could be explained only partly by movements in relative interest rates. It was possible
that it reflected further reaction to previous soft UK data releases and changing views about monetary
policy. Much of the fall in sterling over the quarter occurred at the end of June and early July,
coinciding with the release of the National Accounts for 2005 Q1 and the
Blue Book revisions to
historic data. But the pattern of depreciation did not fit particularly closely with any single piece of
data which made it hard to pinpoint the source of the change in view on sterling. It was also possible
that some of the weaker UK data had been put into a sharper contrast by a backdrop of slightly
stronger news about the global economy.
mpc: 5
Equity prices had increased over the past month in the United Kingdom, the United States and
the euro area. As with the exchange rate, the movements in equity prices between
Inflation Reports
had been substantial; in the United Kingdom, the FTSE All-Share index had risen around 8% since the
May
Report.
mpc: 6
The Committee noted that movements in most asset prices following the terrorist attacks on the 7
and 21 July appeared to have been short-lived. However, since the counterfactual path for these prices
was unknown, it was difficult to conclude with certainty that there had been no longer-term effects.
mpc:
The international economy
mpc: 7
Economic developments in the euro area had seemed slightly more encouraging and, looking
ahead, pointed to a moderate recovery in growth. The second release of the euro area national
accounts data for 2005 Q1 contained relatively little news, with GDP growth unchanged at 0.5%.
Industrial confidence had picked up a little in the larger euro-area economies, and both the
manufacturing and services purchasing managers' indices had risen a little in July. Employment was
growing moderately, and bank lending to private non-financial companies had picked up. The
depreciation of the euro against the dollar over recent months should help to boost net trade. So the
climate in the corporate sector seemed to have improved recently though industrial confidence still
remained below its level at the end of 2004. The outlook for consumption growth, however, continued
to look a little weak, given the data on retail sales and consumer confidence. Core producer price
inflation had ticked down again, while headline consumer price inflation remained above 2%.
mpc: 8
In the United States, GDP growth in 2005 Q2 had been in line with expectations. Final domestic
demand and net trade had both been a little stronger than expected, offset by unexpectedly weak
stockbuilding. Most indicators for consumption, investment, and the labour and housing markets
suggested that prospects remained firm. Both core producer and consumer price inflation had eased in
June. The Committee noted the upward revisions to the core personal consumption expenditure (PCE)
deflator the preferred inflation measure of the Federal Reserve.
mpc: 9
The main news from Asia had been the move to a more flexible exchange rate regime in China.
The initial 2% revaluation should have a negligible impact on the pattern of global production and
trade, but did raise the possibility of further revaluations in the future. The annual rate of Chinese
GDP growth remained strong and had shown no sign of slowing in 2005 Q2. There had been little
news from Japan, on the month. UK trade-weighted Asian import growth had picked up in May and
June.
mpc: 10 The oil price had risen around 5% over the past month, and was just over 20% higher than its
level at the time of the May
Inflation Report.
Looking over a longer time period, what continued to
differentiate the recent rise in the spot oil price from some previous sharp movements was the parallel
upward shift in oil futures prices; implying that market participants expected the rise in spot prices to
persist for some time. Existing spare oil production capacity was historically low and new supply
capacity through, for example, development of new oil and gas fields and building of refineries
would take a considerable time to come on-stream in response to expectations of sustained higher
prices. Continued robust expansion of world activity was unlikely to be consistent with a significant
easing in the growth of oil demand. So there was a risk of a further rise in the oil price.
mpc: 11 Overall, there were some mildly encouraging signs in the UK's primary export markets,
consistent with continuing steady growth in world demand. Corroborative evidence of this view came
from the rise in equity prices and from the Bank's regional Agents, whose contacts reported an
improvement in export prospects.
mpc:
Money, credit, demand and output
mpc: 12 The preliminary estimate of UK GDP growth was 0.4% in 2005 Q2, a little weaker than
expected. Official estimates of GDP growth had now been below trend for four consecutive quarters,
although such early estimates were highly uncertain. The main factor underlying this weakness had
been the below average growth rate of the service sector over this period.
mpc: 13 The official estimates of service sector output continued to look somewhat weaker than the
picture painted by the service sector surveys. The pattern of past revisions to the official data, coupled
with the survey data, suggested that services sector output growth might eventually be revised
upwards. But the survey-based estimates of output were subject to a significant margin of error, and it
was possible that they were not providing an accurate reading at present. Surveys could fail to capture
slowdowns that were particularly concentrated in a few sub-sectors, and survey balances might not
capture the intensity of changes in business conditions. Some of the surveys, such as the CIPS
services survey, excluded the distribution sector which had been a major contributor to weak output
growth in recent quarters. The evidence from the labour market was also broadly consistent with
growth somewhat below trend. Nevertheless, on balance it still seemed likely that recent ONS output
data would eventually be revised up a little.
mpc: 14 The June Index of Production release had been provided to the Committee ahead of publication.
The June outturn, together with revisions to earlier months, suggested stronger-than-expected
manufacturing output in Q2. On the basis of these numbers, it was possible that the ONS might
subsequently revise up the preliminary GDP growth estimate in the next release.
mpc: 15 The survey indicators in July had been mixed, but had not shown signs of a further slowing of
GDP growth in Q3. The CIPS services index had risen a little, as had the output index of the CIPS
manufacturing survey. However, there had been falls in the CIPS manufacturing new orders index,
and the quarterly BCC survey balances looked a little weaker, particularly for the service sector.
Overall, the indicators had pointed to service sector growth in Q3 at around the same rate as in Q2, and
flat manufacturing output.
mpc: 16 Turning to consumption, retail sales had bounced back strongly in June. Anecdotal evidence
from the Agents suggested that sales might have been boosted by protracted discounting, although the
series itself was an erratic one. Retail sales data, coupled with a modest recovery in private car
registrations, had pointed to stronger consumption growth in Q2.
mpc: 17 The latest indicators for household spending in Q3 were mixed. The
CBI Distributive Trades
Survey for July remained weak. In contrast, the GfK survey had risen slightly on the month, and had
shown a pickup in confidence about making major purchases. The July terrorist attacks in central
London had seemingly not had much effect on consumer confidence or the recorded number of people
entering shops across the United Kingdom as a whole. But it was possible that some of the indicators
and official data would be more volatile than normal over the summer. House prices and mortgage
approvals had been broadly flat. Unsecured lending growth had continued to weaken, although it
remained robust. The Bank's regional Agents had reported a somewhat slower growth rate of
consumer services. Overall, the indicators did not yet provide a clear steer as to whether the stronger
consumption growth now expected for Q2 would be maintained into the second half of the year, or
whether the weakness over the first half of the year taking Q1 and Q2 together would continue.
mpc: 18 Contacts of the Bank's regional Agents suggested that investment intentions had fallen in both
manufacturing and services. That picture had been broadly corroborated by the latest business
surveys. This softer outlook had been factored into the Committee's near-term projections for
investment.
mpc: 19 There had not been much labour market news on the month, but the data still seemed consistent
with a gentle labour market loosening since the turn of the year. That was, in turn, consistent with
below trend output growth over the past few quarters.
mpc: 20 Since the beginning of the year, total weekly hours and the employment rate had fallen while
both measures of unemployment had risen a little. Business surveys generally also pointed to a slight
softening of labour market conditions. The Agents had undertaken a survey this month which had
suggested a further slight weakening in employment growth prospects.
mpc: 21 Average earnings growth, as measured by the average earnings index (AEI), had eased a little
since the start of the year, and contacts of the Bank's regional Agents had suggested a slight easing in
total labour costs per employee. The Office for National Statistics' new experimental measure of
annual growth in average weekly earnings (AWE) appeared to be easing, suggesting that the contrast
between the rising AWE measure and weakening AEI measure of regular pay growth had weakened
somewhat.
mpc: 22 The news on prices in the supply chain had been mixed over the past month. On the one hand,
private sector unit labour costs had continued to rise. But the annual rate of increase in unit labour
costs had returned only to around the average of the past decade and, given the prospective weakness
of the employment data relative to the output data in Q2, unit labour costs growth was quite likely to
fall back. Manufacturing input price inflation had risen on the back of the latest rises in oil prices, and
was at its highest rate since the current index began in 1986. On the other hand, manufacturing output
price inflation had eased further, albeit from a relatively high level. The CIPS survey balances for
both input and output price inflation had eased in the service sector. The fall in input and output price
balances across a range of manufacturing and services surveys over recent months had been striking,
leaving many close to their series averages.
mpc: 23 CPI inflation was on target at 2.0% in June, a little higher than expected. Although there was
continuing uncertainty about the reasons for the recent increases in CPI inflation, the oil price was
likely to have played a sizable role through both direct and indirect channels, and looked set to do so
for some time given the continued rise in oil prices. The pressure of demand on supply in early 2004
was also likely to have played a significant role in the rise in inflation towards the target.
mpc:
The August GDP growth and inflation projections
mpc: 24 The Committee reached its policy decision in the light of the projections to be published in the
Inflation Report on Wednesday 10 August.
mpc: 25 The Committee's central projection, based on its collective judgement and the assumption that
official interest rates followed the declining path implied by the market yield curve, was for output
growth to remain subdued in the near term, reflecting the continued sluggishness of domestic demand.
Growth then picked up as the impetus from recent movements in asset prices worked through to
consump tion, investment and net trade. The profile was weaker in the near term than in the May
Report, but stronger further out.
mpc: 26 The central projection for CPI inflation, on the market-based assumption about the path of
official interest rates, was for it to move above the 2% target in the near term and then to dip, as the
impact of recent increases in oil prices moderated and pressures on capacity eased. Inflation was then
projected to rise above the target once more, as output growth picked up and the contribution from
import prices increased. The central projection was a little higher in the near term, and also somewhat
higher in the final year of the projection, than in the May
Inflation Report.
mpc: 27 The Committee's best collective judgement was that the key risks to the central projection
related to: the near-term momentum in consumer spending; the sources of the recent pickup in
inflation; and the outlook for oil prices. While there was a range of views among members, the
Committee's best collective judgement was that, relative to the central projection, the balance of risks
for activity was slightly to the downside in the near term. The balance of risks to inflation was
correspondingly slightly on the downside further out.
mpc: 28 Under the alternative assumption of constant interest rates, output growth was slightly weaker, so
the pickup in inflation towards the end of the projection was less marked. If interest rates were to
remain unchanged at 4.5% that might be a significant surprise to financial markets which were pricing
in a further reduction in interest rates. That could prompt larger movements in equity prices and the
sterling exchange rate than had been assumed in the constant rate projection, constituting a downside
risk to activity and inflation relative to the
Inflation Report central projection.
mpc:
The immediate policy decision
mpc: 29 There had been relatively little news on the international economy over the past month. The
prospect seemed to be one of continuing steady growth, with some mildly encouraging signs in the
United Kingdom's primary export markets. ONS estimates of UK output growth had turned out
weaker than expected in Q2. The latest indicators pointed to similar growth in Q3. But there remained
uncertainty about the prospects for revisions to the data, especially in the service sector. On the
expenditure side, the indicators pointed to some recovery in consumption growth in Q2, but there was
uncertainty as to whether this would be maintained into the second half of the year.
mpc: 30 Since the turn of the year, there seemed to have been a gentle labour market loosening,
consistent with below trend output growth since the middle of last year. There was mixed news in the
supply chain, with producer input prices continuing to rise sharply, but output price inflation easing.
Oil prices had risen further both on the month and since the previous
Report, and continued to be a
major influence along the UK supply chain. CPI inflation was expected to rise above the target in the
near term.
mpc: 31 There had been relatively little news in financial markets over the past month, but there had been
considerable news over the past quarter. In particular, the fall in market interest rates compared with
the flat yield curve at the time of the May
Report implied that the market expected the official interest
rate to fall towards 4%. The effective exchange rate had fallen, while equity prices had risen. Taken
together, these movements in asset prices had a material impact on the projections for output growth
and inflation based on market interest rates.
mpc: 32 The Committee's projections implied that inflation was likely to move significantly above target
in the medium term if interest rates were to move in line with the market yield curve. The constant
rate projection showed slightly lower activity and inflation in line with the target at the two year
horizon.
mpc: 33 For some members, a 0.25 percentage point reduction in official interest rates was necessary this
month. In the first half of the year, output growth in the United Kingdom had been subdued.
Household spending and business investment growth had slowed. Although there had been some signs
of a pickup in consumer spending in Q2, downside risks remained in the near term given the loosening
in the labour market and uncertainty about the underlying strength of consumer spending in the first
half of the year. It seemed likely that the combined effect of high levels of household debt and the
lagged impact of past interest rate increases had accounted for some of the unexpectedly sharp
slowdown in consumer spending through 2004 and into the first quarter of 2005. It was possible that
the uncertainty created by the ongoing adjustment in the housing market had also had some effect on
spending. Higher oil prices might raise inflation further in the short term, but the slackening in the
pressure of demand on supply capacity in the first half of the year should lead to some moderation in
inflation looking further ahead. There was also a possibility that import prices might provide a smaller
contribution to inflation than had been assumed in the central projection. And there had been a sharp
fall in some of the price surveys, indicating less pressure along the supply chain than had been
apparent a few months ago. Although the path of market interest rates should prove supportive of
household spending, it was necessary to validate those expectations to some degree. A failure to
reduce rates now might damage confidence. Early action would reduce the risk that greater changes in
the policy rate would be needed at some point in the future, and would not preclude a rise in rates in
the future if the data warranted it. For these members, there was no presumption on the future
direction of interest rates.
mpc: 34 For other members, the evidence did not require a change in official interest rates this month.
While the growth in aggregate output had slowed, and the labour market had eased a little, the
economy was still operating close to full capacity. Looking ahead, activity was likely to be supported
by fiscal policy and the continuing strength of the world economy. Some of the most recent domestic
indicators had been a little stronger than expected. The services surveys were consistent with slightly
stronger growth than in the official data, and the recent industrial production data had been stronger
than expected. The money and credit data had not pointed to a marked further softening in activity;
rather, they were consistent with a recovery in consumption and GDP growth in the second half of the
year. The housing market appeared to be stable, with house prices broadly flat and activity indicators
picking up a little. With oil prices likely to remain strong, producer input prices rising sharply, and an
acceleration in unit labour costs since the turn of the year, it was too early to conclude that inflationary
pressures had abated. Adding to the strength of the recovery would risk adding to inflationary
pressures while costs were still working their way through the supply chain.
mpc: 35 For these members, while it was possible to build a case for a precautionary reduction in interest
rates, based on the near-term downside risk to consumption, there appeared to be little risk in waiting
for further data. Given the difficulty in explaining a reversal of a decision soon after a turning point,
should that prove necessary in the light of future data, it was advisable to accumulate a little more
evidence than usual before changing interest rates. While a decision not to cut rates would be a
significant surprise, the Committee's latest projections did not support the current market view that a
sequence of interest rate cuts was likely to be needed to meet the inflation target in the medium term.
mpc: 36 The Governor invited members to vote on the proposition that the repo rate should be reduced by
25 basis points to 4.5%. Five members of the Committee (Kate Barker, Charles Bean, Richard
Lambert, Stephen Nickell and David Walton) voted in favour. Four members of the Committee (the
Governor, Rachel Lomax, Sir Andrew Large and Paul Tucker) voted against, preferring to maintain
the repo rate at 4.75%.
mpc: 37 The following members of the Committee were present: Mervyn King, Governor Rachel Lomax, Deputy Governor responsible for monetary policy Andrew Large, Deputy Governor responsible for financial stability Kate Barker Charles Bean Richard Lambert Stephen Nickell Paul Tucker David Walton Jon Cunliffe was present as the Treasury representative.