Minutes of Monetary Policy committee meeting (2006-02-08)
mpc:
MINUTES OF THE MONETARY POLICY COMMITTEE MEETING HELD ON 8-9 FEBRUARY 2006
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
Domestic short-term interest rates had ended the month a few basis points higher than at the time
of the January meeting. Sterling money market instruments implied that interest rate expectations
were broadly flat over the next year or so, and were close to where they stood at the time of the
November
Inflation Report. According to the Reuters survey, the mean expectation of private sector
economists had remained for one interest rate reduction this year.
mpc: 3
Both UK and US long-term implied forward interest rates had been little changed on the month,
though in each case there had been a small fall in forward real interest rates offset by a small rise in
inflation expectations. There had been a rise in long-term forward rates in the euro area, the reasons
for which were unclear.
mpc: 4
The sterling effective exchange rate index (ERI) had been flat over the past month, but had fallen
by around 1% since the time of the November
Inflation Report. Looking back over a longer period,
sterling had been broadly stable within a fairly narrow range. The dollar had appreciated over the past
month against both the euro and yen. The movement in the dollar-euro exchange rate was perhaps a
little surprising given the upward shift in longer-term euro-area interest rates.
mpc: 5
Equity prices were little changed over the past month in the United Kingdom and the euro area,
while the US S&P 500 index had fallen a little. Most major equity price indices had remained
significantly higher than at the time of the November
Inflation Report.
mpc:
The international economy
mpc: 6
After several months of generally positive news on activity, the latest indicators for both the
United States and the euro area had seemed more equivocal.
mpc: 7
In the euro area, the retail sales and trade data had pointed to slightly slower growth in 2005 Q4
than thought a month or two ago. However, this slight reassessment of the likely outturn for Q4 did
not alter the picture of a steady recovery in growth, with the services Purchasing Managers Index
(PMI) and the European Commission industrial confidence balance both strengthening. A key
question remained whether consumption growth would pick up further. But with signs that firms were
expecting to employ more labour and household borrowing strong, the outlook seemed fairly positive.
mpc: 8
Growth in the United States had slowed to 0.3% in Q4, the slowest quarterly growth rate since
2002. Although the slowdown was broadly based across expenditure categories, there were a number
of reasons for discounting the slowdown as erratic. These included: the impact of the hurricanes on
both consumption and the production of oil and gas; the unwinding of incentives on auto purchases;
the impact of a strike at Boeing on investment; and an erratic fall in defence spending. Consequently,
GDP growth seemed likely to bounce back in Q1. That being said, some of the January indicators had
been a little weaker than expected, for example the latest non-farm payrolls data and the non-
manufacturing purchasing managers' index
.
mpc: 9
There was a possibility that there might be a more sustained period of adjustment in the United
States, particularly in the housing market, with house sales and housing construction indicators both
easing recently. The house price inflation rate had fallen in November and December, while forward-
looking indicators of activity had also edged lower in recent months. A slowdown in the US housing
market would probably have implications for consumption and private residential investment. But just
as in the United Kingdom, the correlation between house price inflation and consumption growth had
fallen in recent years, and so although some further dampening of consumer spending was possible, it
was not clear how far any adjustment in the housing market would affect consumption growth.
mpc: 10 The latest Japanese indicators appeared to confirm that the weakness in growth in Q3 had been
temporary, and pointed to a rebound in Q4. The rest of Asia still seemed to be growing strongly.
mpc: 11 Oil prices had risen through most of the month, but had fallen back just before the policy
meeting to end the period broadly unchanged. This volatility seemed largely to reflect concerns about
the potential for oil supply disruptions in Nigeria and the Middle East. There remained significant
uncertainty about the future path of oil and other energy prices. Option contracts suggested that
financial market participants thought the risks to future oil prices were skewed to the upside. Non-oil
commodity prices had increased strongly in recent months, which seemed likely to reflect the
acceleration in world industrial production and expectations of continued growth.
mpc: 12 Core measures of both producer and consumer price inflation in the United States and the euro
area had remained subdued, but headline measures of consumer price inflation had been a little higher.
mpc:
Money, credit, demand and output
mpc: 13 The preliminary estimate for GDP growth in the United Kingdom was 0.6% in Q4. Service
sector growth had picked up significantly. The subsequent industrial production release showed that
manufacturing output had fallen by 1% in Q4, which was weaker than had been assumed by the Office
for National Statistics (ONS) in the preliminary GDP release. The surveys for manufacturing had
remained more upbeat than the official output data. It was difficult to know how much of the recent
weakness was due to cyclical developments, and how much was the continued influence of longer-
term structural factors, such as increased competition from low-cost producers in emerging market
economies. Energy production had risen a little in Q4, rebounding from the very weak level in Q3.
Over the longer term it had been on a declining trend.
mpc: 14 The output indicators for Q1 had remained reasonably strong. The CIPS/RBS services business
activity index had fallen slightly following the strong rise in December, but remained above the broad
range it had occupied for much of the past two years. The CIPS/RBS manufacturing index had
remained unchanged in January. Taken together, the surveys pointed to slightly faster GDP growth in
2006 Q1 than in 2005 Q4. It was important not to place too much weight on small movements in
measured GDP growth rates from quarter to quarter, given that the profile might look somewhat
different after the ONS had received more information, and the data had gone through the normal
cycle of revisions.
mpc: 15 As far as the expenditure data were concerned, a key question remained the near-term strength of
consumption. Retail sales had risen strongly in Q4, and at the fastest rate since 2004 Q2. The BRC-
KPMG
Retail Sales Monitor and CBI
Distributive Trades Survey both suggested some moderation in
the pace of growth in January. Vehicle registrations had remained weak. The Bank's regional Agents
suggested that consumer services growth had picked up.
mpc: 16 The recent slackening of employment growth and the rise in unemployment could weigh on
future consumer spending growth. However, housing market activity and prices continued to point to
a pickup in the housing market. This could be indicative of strengthening confidence and reduced
uncertainty on the part of households. The average of the lenders' house price indices had risen 1¾%
in the three months to January compared with the previous three months, and loan approvals for house
purchase had risen back towards the levels recorded in the second half of 2003 and first half of 2004.
mpc: 17 While secured lending growth had remained above 10% at an annualised rate, which was
consistent with the strengthening housing market, the growth rate of unsecured credit had slowed in
recent quarters. The average monthly flow of unsecured credit had now fallen to around half the rate
of a year ago. Within unsecured credit, the annual rate of growth of credit card lending had also
halved over the past year. The annual growth rate of the M4 monetary aggregate had increased to
12.6% in December, the highest rate since 1990.
mpc: 18 The Labour Force Survey (LFS) measure of the unemployment rate increased to 5.0% in the
three months to November, the highest since 2003. That rise in unemployment reflected both an
unexpectedly weak employment rate, and an unexpectedly high participation rate. The slackening in
the employment rate might have reflected the beginning of an unwind in the labour hoarding that had
been a possible explanation for the low productivity growth recorded recently. If that were the
explanation, it was possible that employment growth could remain subdued for at least another quarter
or two. Against that, there were some signs from business surveys that this slowing would prove
temporary. The Bank's regional Agents had reported that companies, on average, were planning to
increase employment, particularly in business services.
mpc: 19 There had been little news on pay settlements since the January meeting. The annual rate of
regular pay growth ticked down, and overall earnings growth fell sharply in the three months to
November. The Bank's regional Agents had reported the results of an informal survey which indicated
that pay settlements and pay growth might edge up a little this year. It was too early to be confident
that there would be no second round effects on earnings from the rise in energy prices.
mpc: 20 The weakness in average earnings growth in recent months had been a little surprising, given
that some surveys and anecdotal evidence had pointed to stable, or faster, growth. The ONS
experimental series for Average Weekly Earnings had recorded a slightly stronger profile than the
Average Earnings Index. It was possible that the recent weakness in the growth of average earnings
had reflected the timing of bonuses this year compared to last, and that the bonus contribution would
bounce back. It was also possible that the recent fall in earnings growth reflected falls in overtime and
other elements of non-basic pay that were related to productivity and profits, and reflected weaker
activity in the first half of 2005. If so, earnings growth might pick up, reflecting the strengthening in
activity seen in the second half of 2005.
mpc: 21 As the Committee had previously discussed, the recent rises in energy prices implied the need
for an adjustment in real wage growth. The rise in energy prices would require the growth rate of the
real consumption wage to be slower than it otherwise would have been if employment growth were to
be sustained. This adjustment could come about via higher inflation, lower nominal wage growth, or
some combination of the two. It was possible that firms were reacting to increased energy costs by
putting additional downward pressure on their other costs including labour costs. So some of the
adjustment might be coming through average earnings as well as in prices.
mpc: 22 It was difficult to know whether the rise in energy prices had had any adverse effects on supply
thus far, though it was probable that any effects on investment and supply would take some time to
feed through. But, equally, it remained difficult to know by how much migration was boosting
potential supply.
mpc: 23 In line with pre-release arrangements, an advance estimate of CPI inflation for January had been
provided to the Governor ahead of publication. This had indicated that inflation was 1.9% in January.
There were also revisions to the past data. In particular, the December inflation rate had been revised
down from 2.0% to 1.9%. Since the November
Inflation Report, inflation outturns had been a little
lower than expected.
mpc:
The February 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 15 February.
mpc: 25 The Committee's central projection, based on its collective judgement and the assumption that
official interest rates followed the path implied by the market yield curve, was for the four-quarter
growth rate of GDP to move slightly above its historical average as the quarters of weak growth in
2005 dropped out of the calculation. It then eased back in the second half of the projection as domestic
demand growth moderated. Compared with November, the profile was a little stronger in the first part
of the projection, but slightly weaker thereafter. The central view implied a steady expansion of
consumer spending, but business investment growth was likely to remain soft in the short term. Net
trade was assumed to make a broadly neutral contribution to GDP growth during the forecast period
with a stronger assumed profile for import penetration, and a weaker assumed profile for UK
exporters' market share, than three months ago.
mpc: 26 The central projection for CPI inflation, on the market-based assumption about the path of
official interest rates, was for it to remain close to the 2% target throughout the forecast period, as a
declining contribution from the prices of energy and imported consumer goods was offset by a gradual
increase in the pressure of demand on capacity. Compared with November, the profile was slightly
higher around the end of the first year of the projection, mainly on account of the further increase in
energy prices, but similar further out.
mpc: 27 The Committee's best collective judgement was that the key risks to the central projection
related to: the outlook for consumer spending; the prospects for net exports; the sustainability of low
long-term interest rates; the margin of spare capacity; the evolution of energy prices and their impact
on inflation. There was a range of views among members, but the Committee judged that, relative to
the central projection, the overall risks were to the downside for growth and broadly balanced for
inflation.
mpc: 28 The Committee's projections for GDP growth and CPI inflation conditioned on a constant
interest rate of 4.5% were similar to those based on market rates, reflecting the broadly flat interest rate
profile implied by the market yield curve for the next two years.
mpc:
The immediate policy decision
mpc: 29 Against this backdrop, there were a number of arguments in favour of leaving the Bank's official
interest rate unchanged, to which different members attached different weights.
mpc: 30 There had been relatively little news in financial markets over the past month, though the news
over the past quarter should provide some stimulus to growth. Although the central projection was for
global growth to be slightly stronger than projected in November, there remained risks in both
directions to the prospects for demand growth in the UK's primary export markets. The preliminary
ONS estimate of UK output growth had increased in Q4, largely reflecting the strength of services
output and a turnaround in energy production. The earlier slowdown in output growth therefore
appeared to have been relatively shallow. Growth was now close to its historical average rate. The
latest indicators and surveys had pointed to GDP growth strengthening a little in Q1.
mpc: 31 The weakness of consumption growth in the first half of 2005 appeared to have abated, but the
prospects for consumption were still uncertain. There were signs of weaker growth in some of the
more recent indicators, although the housing market had been stronger than expected. Looking further
ahead, there was uncertainty about whether post-tax labour income would pick up as quickly as
expected in the central case, and about whether households would seek to improve their financial
position by increasing their saving rate. Nevertheless, for most members the near-term outlook for
consumption growth looked stronger than at the time of the November
Report. Overall, most members
thought that a gradual strengthening of GDP growth was the most likely central case, though with the
balance of risks on the downside. There was some concern that a reduction in interest rates at this
stage would provide further support to the housing market and consumption at a time when GDP
growth was already strengthening, and that would increase the probability of inflation rising above the
target in the medium term.
mpc: 32 Consumer price inflation remained close to target, and inflation expectations appeared to be well
anchored. Gas prices seemed likely to push up on inflation to a greater extent than had been expected
in November, and there remained uncertainty about the future path of energy prices more generally.
The central projection was for inflation to remain close to target, as a declining contribution from the
prices of energy and imported consumer goods was offset by a gradual increase in the pressure of
demand on capacity. Business surveys and evidence from the labour market had been consistent with
there being some margin of spare capacity, although there was considerable uncertainty about its size.
In particular, it was hard to judge how much supply capacity had been and would be eroded by the
increase in energy prices. In the light of these considerations, it seemed appropriate to leave the repo
rate unchanged.
mpc: 33 For one member there was a case for an immediate reduction in the repo rate. The fall in GDP
growth below its historical trend for much of the past eighteen months, the recent rise in
unemployment and the surveys of capacity utilisation, pointed to the emergence of spare capacity in
the economy. While the outlook for consumption had improved over the recent past, the central
projection for consumption and investment appeared too optimistic. Consequently, it appeared
unlikely that the degree of spare capacity in the economy would diminish as much as had been
envisaged in the central projection. And given that pipeline pressures were modest, it seemed likely
that inflation would fall below target once the effects of higher energy prices had dropped out of the
year-on-year calculations.
mpc: 34 The Governor invited the Committee to vote on the proposition that the repo rate should be
maintained at 4.5%. Eight members of the Committee (the Governor, Rachel Lomax, John Gieve,
Kate Barker, Charles Bean, Richard Lambert, Paul Tucker and David Walton) voted in favour.
Stephen Nickell voted against, preferring a reduction in the repo rate of 25 basis points.
mpc: 35 The following members of the Committee were present: Mervyn King, Governor Rachel Lomax, Deputy Governor responsible for monetary policy John Gieve, 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.