Minutes of Monetary Policy committee meeting (2005-09-07)
mpc:
MINUTES OF THE MONETARY POLICY COMMITTEE MEETING HELD ON 7-8 SEPTEMBER 2005
1
Before turning to its immediate policy decision, the Committee discussed developments in
financial markets; the oil market; the world economy; money, credit, demand and output; and the
labour market, costs and prices.
mpc: 2
The Committee's August decision to reduce the Bank of England's interest rate by 0.25
percentage points had been fully anticipated by market participants and consequently had had very
little impact on financial markets. However, immediately following the release of both the August
Inflation Report and the
Minutes of the Committee's August meeting, UK short-term market interest
rates had increased and sterling had appreciated. These developments appeared to be a reaction to the
published forecasts for growth and inflation contained in the
Report, which had been stronger than
market participants had anticipated, as well as the closeness of the Committee's vote.
mpc: 3
These immediate financial market movements had been broadly in line with what the Committee
had anticipated. Nevertheless, over the month as a whole, short-term market interest rates had
declined, while sterling had appreciated and equity prices had increased a little. Taken together, these
developments were more difficult to explain.
mpc: 4
The fall in short-term interest rates could have reflected a reaction by market participants to
domestic activity data releases, which may have been perceived to point to continued below trend
growth.
mpc: 5
Despite the fall in short-term interest rates, the sterling effective exchange rate index (ERI) had
appreciated by 2.5% since the Committee's August meeting. Even after taking into account a fall in
US short-term interest rates, sterling's appreciation could not be explained by movements in relative
interest rates. Long-term sterling real interest rates had fallen by around 20 basis points. The FTSE
All-Share index had increased by 0.9%.
Oil
mpc: 6
The US dollar price of Brent crude oil had increased by around 5% since the Committee's
previous meeting, leaving it roughly twice its level at the beginning of 2004. In addition, natural gas
and petroleum prices had increased sharply in the United States. As the Committee had discussed on
previous occasions, most of the price rise over the previous 18 months appeared to have reflected the
combined effects of strong growth in the global demand for oil (particularly in the US and China) and
limited spare global production capacity. These effects had been augmented in the past month by the
supply shock emanating from the damage caused by Hurricane Katrina. Over the month as a whole,
long-term oil futures prices had increased by much less than the observed rise in spot prices,
suggesting that market participants viewed the hurricane-induced rise in oil prices as likely to be
temporary.
mpc: 7
In the first week of September, spot prices for crude oil had fallen back, reflecting the decision
by member countries of the International Energy Agency to release stocks of oil products and
indications by Saudi Arabia that it would be willing to increase its oil production. But wholesale
prices for natural gas and petrol had at that stage only fallen back slightly. There remained
considerable uncertainty about the time it would take to restore the damaged oil refinery and natural
gas facilities.
mpc: 8
The Committee considered the prospects for future oil demand and supply growth. Strong
increases in oil demand over the past three years were likely to have been related both to cyclical and
structural factors, with the latter primarily reflecting the rapid expansion of China. The Committee
noted that it was difficult to separate out cyclical and structural considerations; as a result, forecasts of
demand were very uncertain.
mpc: 9
Forecasts of future oil supply growth were subject to even greater uncertainty. Estimates of the
price elasticity of oil supply in non-OPEC countries varied widely, and the oil sector investment and
supply decisions of OPEC countries were influenced by a range of considerations that were not easy to
forecast. Given that new investment in oil extraction often took five to seven years to come on stream
and that global spare production capacity remained at historically low levels, the Committee judged
that oil prices could remain high for some while and might even rise further in the near term.
mpc: 10 The continued rise in the oil price presented a dilemma for monetary policy. The key question
was how to choose an interest rate path that kept inflation expectations well-anchored. The choice of
interest rate path depended both on the size and location of real rigidities in the economy and on
whether oil prices continued to rise. Regardless of the path chosen for interest rates, the growth rate of
the real consumption wage would be somewhat lower than it otherwise would have been.
mpc: 11 The Committee could choose to accommodate the first-round impact of higher oil prices and
allow headline CPI inflation to rise temporarily above the target. If wage settlements did not pick up
in line with the increase in CPI inflation, this would reduce the growth of real consumption wages.
But this accommodative strategy could prompt an increase in agents' inflation expectations and an
associated rise in wage settlements. If this were to occur, the tightening in monetary policy needed to
bring inflation back to target might be associated with larger fluctuations in output and employment.
mpc: 12 Alternatively, monetary policy could respond to the first-round effects of the oil price shock and
seek to bring CPI inflation back to target more quickly, thereby limiting any change in agents'
inflation expectations. This would imply a tighter monetary policy in order to reduce inflation in the
non-oil sector, offsetting the direct effects arising from higher oil prices. This would push down on
growth and employment, reducing the growth in real consumption wages through lower wage
settlements.
mpc: 13 In considering these issues, the Committee noted that the various measures of inflation
expectations (both from surveys and derived from government bonds) had remained well-anchored in
recent years. They also noted that, over the past twelve months, whole-economy average earnings
growth had not picked up by as much as the rise in CPI inflation. This was consistent with the gradual
easing in the labour market. It might also have partly reflected the fact that RPI inflation which was
more often used as a benchmark in wage bargaining had fallen back in 2005.
mpc:
The international economy
mpc: 14 Over the month, the most significant event affecting the UK's major trading partners had been
the damage caused by Hurricane Katrina in the United States. Early estimates of the physical damage
ranged up to 0.8% of 2004 US GDP. The preliminary assessment of most private sector economists
was that hurricane-related effects were likely to push down slightly on US GDP growth in the third
and fourth quarters of this year and that thereafter the positive effects on growth arising from
reconstruction would probably dominate. This assessment appeared consistent with the relatively
modest movements in US equity prices during the month and with the experience after previous
natural disasters. The Committee noted, however, that there remained uncertainty about the likely
economic impact arising from Hurricane Katrina.
mpc: 15 US data published since the Committee's August meeting related to the period prior to the
damage inflicted by Hurricane Katrina. These data generally pointed to continued robust growth,
particularly in the non-manufacturing sectors. The personal sector savings rate had turned negative in
July, reaching its lowest level since the 1930s. Taking this news together with the strong increases
seen in house prices, suggested that the risks of a correction in US consumption might have increased.
mpc: 16 In the euro area, quarterly GDP growth in the second quarter had been 0.3%; the annual growth
rate had slowed to 1.1%. The expenditure decomposition of this growth showed a fall in consumption,
weak investment growth, and an increase in stocks. On the available indicators, GDP growth in Q3
was likely to be broadly similar to that seen in Q2. Overall, this news seemed broadly consistent with
the outlook for the euro area at the time of the August
Report.
mpc: 17 News over the month pointed to continued strong growth by the Asian economies and the
Japanese Q2 National Accounts data had highlighted better-than-expected consumption and
investment. Overall, UK trade-weighted world import growth appeared to have rebounded in the
second quarter, following the erratically weak growth in Q1. Reflecting these developments, the
outlook for the United Kingdom's major export markets was broadly in line with the assessment made
at the time of the August
Inflation Report.
mpc:
Money, credit, demand and output
mpc: 18 The second release of the Q2 National Accounts had revised up quarterly UK GDP growth by
0.1 percentage point, to 0.5%. This change had reflected an upward revision to the estimate for
manufacturing output growth, which the Committee had been aware of at the time of its August
meeting. However, the service sector output figures had been left unrevised and continued to look
weaker than the service sector surveys.
mpc: 19 The National Accounts provided the first expenditure breakdown of GDP for the second quarter.
Consumption was estimated to have increased by 0.2% in Q2, only marginally stronger than the 0.1%
growth recorded in Q1. The continued weak consumption growth in Q2 appeared to have reflected a
sharp decline in spending by UK residents on overseas trips. This fall in spending abroad looked
unusual relative to the past behaviour of this series and it was possible that it would be revised
upwards when more comprehensive data became available, with an offsetting change in net exports.
mpc: 20 Whole economy investment and exports had both increased sharply in Q2, rising by 2.0% and
4.3% respectively. Here too, however, there were reasons to be cautious in interpreting the data. The
investment figures had frequently been heavily revised in the past. And, the pickup in exports had
primarily reflected a surge in exports to non-EU countries; this may have reflected seasonal
adjustment problems relating to the new trade reporting system, or be a by-product of fraudulent
activity. Offsetting the strength of investment and exports in the Q2 National Accounts data,
inventories (including the alignment adjustment) were estimated to have subtracted 0.7 percentage
points from GDP growth.
mpc: 21 The available indicators for July and August suggested quarterly GDP growth broadly in line
with that seen in Q2. On the output side of the accounts, manufacturing activity had increased by
0.1% in July but energy output had fallen by 1.9%; as a result, industrial production was 0.3% lower
than its level in June. The output balance of the CIPS manufacturing survey had increased to 52.0 in
August, suggesting a slight strengthening in the growth rate of manufacturing output. In contrast,
however, manufacturing orders in the CBI Monthly Trends survey had declined in August. Although
the CIPS services business activity balance had fallen back slightly in August, it remained at around its
level for the previous twelve months.
mpc: 22 On the expenditure side, the three-month on three-month growth rate of retail sales had picked
up to 0.7%, despite a slight fall in July sales. Housing market indicators suggested some modest
improvement, with a stabilisation of prices and a further small increase in the number of loan
approvals for house purchase. Car registrations had fallen in the three months to August and the
Bank's regional Agents had reported some easing in the growth of demand for consumer services and
a subdued outlook for retail sales. Other surveys of consumer spending and confidence painted a
mixed picture.
mpc: 23 The annual growth rates of secured and unsecured lending had remained quite high although
both had been slowing. The growth rates of narrow and broad money had picked up in recent months.
mpc:
The labour market, costs and prices
mpc: 24 The latest data continued to suggest a gentle softening in labour market conditions. This was, in
turn, consistent with below trend output growth over the past few quarters. In Q2, the employment
rate had declined slightly and unemployment and inactivity had edged upwards. The available survey
evidence, including that from the Bank's regional Agents, had suggested some weakening in
employment intentions in Q3.
mpc: 25 Whole economy average earnings had risen 4.2% in the year to June, a slight decline from the
growth rate recorded in Q1. The available evidence relating to wage settlements indicated that
agreements struck in July were also slightly lower than those seen in the first half of the year. The
Bank's Agents had reported that pay pressures had remained subdued in most sectors, reflecting the
softer labour market and the effect of inward migration of workers, particularly from other European
countries.
mpc: 26 The news on prices in the supply chain had largely been on the upside. The rise in oil prices,
together with the effects of robust world demand growth in 2004 had contributed to a pickup in import
price inflation to 2.7% in Q2, from -1.0% a year earlier. Manufacturing input price inflation had risen
to 13.4% in July, largely reflecting the impact of higher oil prices. Although firms were continuing to
absorb much of these input price increases, manufacturers' output price inflation (excluding duties)
had also increased in July, rising to 3.1%. Excluding petroleum products, however, output price
inflation had been more modest, at 1.5% in July. The CIPS survey balances for input and output prices
had picked up in August for both manufacturing and service sector firms after several months of easing
balances.
mpc: 27 CPI inflation had increased to 2.3% in July. This was a higher figure than had been expected
and was up from 1.1% in September 2004. The inflation rates for both goods and services had
increased in July, with the former suggesting that price discounting by retailers may not have been as
widespread as previously thought. In line with pre-release arrangements, an advance estimate of CPI
inflation in August had been provided to the Governor ahead of publication. This indicated that CPI
inflation had increased further to 2.4%. While it seemed likely that less than half of the pickup in
inflation since September 2004 had been related to the direct and indirect effects of higher oil prices,
there were a number of uncertainties surrounding such calculations.
mpc:
The immediate policy decision
mpc: 28 Committee members were in agreement that the near-term outlook for UK-weighted world
demand growth seemed broadly similar to the one at the time of the August
Inflation Report. While
there remained uncertainty about the likely effects of Hurricane Katrina on US GDP growth, past
experience suggested that those effects might be relatively small and short-lived. However, higher oil
prices continued to pose a downside risk to world demand and an upside risk to world export prices.
mpc: 29 On the domestic front, the slight upward revision to Q2 GDP left growth slightly below trend for
the fourth quarter in a row. Consumption growth had been weaker than expected, but this may have
reflected mismeasurement issues relating to the net tourism figures. Acting in the opposite direction,
export growth might have been overstated. Overall, Committee members felt it would not be
appropriate to attach much weight to the expenditure decomposition at this early stage in the data
reporting cycle. Data releases and survey indicators relating to July and August suggested that GDP
growth in Q3 was likely to be broadly similar to that in Q2.
mpc: 30 Committee members were in broad agreement about the nature of the risks to the outlook for
inflation. But members attached slightly different weights to the various risks. UK consumption and
business investment and euro-area domestic demand had continued weak. If sustained, these
developments were likely to push down on UK GDP growth and deliver a lower inflation outturn than
the one envisaged in the August
Inflation Report. Sterling's appreciation would also push down on
inflation. However, equity prices had continued to increase, money growth was strong, and activity
developments over the previous month could be viewed as having been broadly consistent with the
August
Inflation Report. Inflation outturns had also been higher than anticipated over the past year
and reflected more than the impact of higher oil prices. There remained a risk that oil prices would
rise further. This posed an upside risk to the inflation projection. But, there were few signs of any
second-round effects arising yet from the increase in oil prices. Inflation expectations appeared to be
well-anchored, though there was no room for complacency.
mpc: 31 Give these considerations, the Committee agreed that it was appropriate to leave interest rates
unchanged.
mpc: 32 The Governor invited the Committee to vote on the proposition that the repo rate should be
maintained at 4.5%. The Committee voted unanimously in favour of the proposition.
mpc: 33 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.