Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 100 - 119)

THURSDAY 13 JUNE 2002

RT HON SIR EDWARD GEORGE, MS KATE BARKER, MR DAVID CLEMENTI, MR MERVYN KING AND MR STEPHEN NICKELL

  100. The Halifax in a recent press release said that UK house prices rose by 4.2 per cent in May, seasonally adjusted, the biggest monthly rise on record. You are telling us that you are a little surprised by what is going on. The nine of you are paid to know what is going on, are you not? Do you have a grip of what is going on in the housing market, Governor?
  (Sir Edward George) If we were paid to know what was going on, I think we would expect to receive rather more than we do! We cannot claim to know month by month what is happening with these numbers. Looking at house prices, it is probably more sensible to look at the last two months taken together, and both the Halifax and the Nationwide say that is 4 per cent plus, and that is unsustainably strong; there is no question. I was talking about moderating consumer demand in the context of the recovery of the global economy. That would be an element which we would be watching very closely—not per se, but in the context of its implications for the strength of consumer demand and the strength of aggregate demand and the implications for inflation, which is our job—retail price inflation rather than house prices.

  101. Again, Sushil Wadhwani, who seems to be the ghost at this banquet, said, "I believe a clear signal from monetary policy makers that they would react to a housing market bubble if one clearly emerged would make the continuance of strong house price growth less likely now."
  (Sir Edward George) In earlier discussion we have made it very clear that if consumption growth continues at its recent rate, driven in part by house prices, we would have to act to moderate that, and I think that is a clear signal. In fact, the Chairman was asking me earlier on whether we were actually saying that monetary policy may have to tighten, to which the answer is yes, it may, if the slowdown does not appear of its own accord.

  102. So you can influence the housing market by signalling that you would respond to a bubble.
  (Sir Edward George) We are saying that we would respond if consumption growth continued at its recent rate in an environment where the international situation was improving. We cannot and would not pick out the housing market as an element in itself. We are not in the business, and I do not think we can be in the business of seeking to control house prices, any more than we can seek to control other asset prices, equities and so on.

  103. Let me try the Deputy Governor. How would you explain the recent increase in housing prices?
  (Mr Clementi) It is plain that house buyers have taken the view that, with the lower nominal rates of interest, they can afford to gear up to a greater extent than they have hitherto, but from our side, the first point which I would certainly stress is that which the Governor has already, and it is important to keep stressing it, because however often we say it, people still misconstrue it: we are in the business of targeting RPIX inflation and not house prices. I still keep reading that the MPC is ignoring house prices or that we should target it. We are targeting RPIX inflation. House prices are relevant to overall inflation, but it works not directly; it works through consumer spending. So we do not ignore it; we take it into account. Nevertheless, no-one should be confused about what we are seeking to do. We are in the business of targeting RPIX inflation. On the current level of house prices themselves—we look at all the ratios and there is not one that tells the full story; you have to look at the lot—I think it is appropriate that home buyers and lenders should exercise a degree of caution. But, for myself, I would not want to be painted into either corner: on the one hand to be told that there is likely to be an immediate and sharp crash in prices—that is not our central expectation—nor would I want to be painted into the other corner of being told we are completely complacent about it and not concerned. As I say, our message is a degree of caution about it, that is, about absolute levels. But you can give a more definitive answer, as I think we have, on the question of house price inflation. I for one said in April that the level of house price inflation, then running in the mid teens, was unsustainable, and since then we have actually seen, if anything, in the last two months' data since I said that, something of an acceleration. So I think it bears repeating yet again: the level of house price inflation, the growth in prices, is unsustainable, and the longer it goes on for, the sharper is likely to be the eventual adjustment.

Mr Tyrie

  104. The sharper the adjustment, the bigger the shock there will be to the conduct of monetary policy. Do you not eventually have an interest in making the policy job you will have later easier by taking it into account in assessing asset price inflation now?
  (Mr Clementi) I agree with that. We do take it into account. We look at asset prices. We look at the equity prices as well. They are actually very much lower, as you know, than18 months or so ago. We look at equity prices, we look at asset prices in the housing market, and all of these feed through into consumption through wealth effects. As I have indicated, we do take them into account, but we are not targeting either equity prices or house prices; our mandate is entirely clear: it is that we target RPIX inflation.

  105. No-one is disputing your mandate. This is just a discussion about how you arrived at making sure two years out—and that is generally what you are looking at, although there has been some discussion that it may be slightly more or slightly less—you are taking the right decisions now to enable you to stay close to target. Let me put the question slightly differently: let us suppose house prices doubled. Are you interested then in bursting the bubble? Does that move this particular bit of asset price inflation into a special category, into a category that could be very destabilising for the whole economy?
  (Mr Clementi) With great respect, I have said we are interested in them now. We do not have to hypothecate a doubling in house prices for us to become interested. We are interested now, but the message is that we are not in the business of targeting house prices. We take asset prices into the model to look at what it means, largely for consumption. We still read that the MPC is ignoring house prices. We do not ignore house prices, but it is not our direct target.

  106. So it does not really matter what house prices do; you will set interest rates at a level that you think will achieve your inflation target on a two-year period, and only take into account the consumption effects of the increase in house prices. I think that is what you said a moment ago.
  (Sir Edward George) I do think this is distorted. We absolutely take account of house prices. We do not believe that the rate of increase in house prices that we have seen recently is sustainable, but it is a factor which is actually driving forward consumer spending, and that does matter to us. If it continues for long at this kind of rate, we would expect to see the moderation in consumer spending which we expect and need, because external demand will be increasing as we go through the year, and then we will have to act to moderate it. In that sense, you cannot possibly say that we do not care about house prices. What we are saying is you have to take it in the total picture, which is what we are trying to do. We do take it very seriously, but it is not a unique factor. If we were to try to target particular unique factors, there are all kinds of factors that we would be trying to target. We have to put them into the overall assessment, and we have one interest rate.

  107. Let us get away from house prices and talk about an asset price bubble. If you reached a stage where you were sure that there was a huge asset price bubble in the economy—there was one in Japan, which has burst and generated ten years of zero growth—do you think that it is the responsibility of the MPC at least to speak out, even if it does not change its policy, as early as it possibly can to say, "We think that some policy action is required to deal with the developing asset price bubble"?
  (Sir Edward George) I think the role of the MPC is to do everything it can to anticipate the consequences of the developments in the economy, including asset prices, and of course, if we anticipated that we were going to have a kind of Japanese impact and that demand considerations, which is what we can influence directly, were going to cause this, yes, we would not just speak out but we would act to fend that off.

  108. You would raise interest rates to fend that off?
  (Sir Edward George) If we were expecting as a result of our expectation that we were going to see an exaggerated boom in asset prices, or exaggerated strength, which was suddenly going to stop, and that was going to cause us to undershoot the inflation target, there could be an argument for saying, "Yes, we must try to restrain the upside because we need to avoid the downside."

  109. So the fact that you have decided not to say explicitly you are taking action of that kind in respect of house prices must indicate you are not expecting a boom and bust in the housing market.
  (Sir Edward George) It must indicate that we are not expecting a boom-bust in the housing market which would cause us, as we look forward over the forecasting horizon, during the bust period to undershoot the inflation target substantially. That is not what we are forecasting, but I could envisage circumstances in which we might forecast that. It is just that our judgement is we are not at that point.

  Mr Tyrie: It is useful to have that on the record. No doubt in a year or two we will have another canter round the same subject.

Mr Cousins

  110. Could I ask Mr Clementi something? A very interesting recent paper concluded by saying that central bankers are paid to worry. The Governor has just expressed the view that you are not paid enough, and my colleagues have just expressed the view that maybe you are not worrying enough. I hear you say that central bankers are paid to worry, and you do express some concerns about some of the new financing devices that are underpinning the growth in household borrowing. Do you have any concerns, bearing in mind the Abbey National situation in their reports this week, about these factors and financial stability?
  (Mr Clementi) I do not have any comments about the Abbey National's results, which I think were largely in their wholesale business, not in their main mortgage retail business. I do have some concerns, as I have indicated, generally in terms of the level of household credit, which has been growing very rapidly. I think it is a moment for considerable caution from the point of view of both those borrowing and those doing the lending. I do not think that what underpins most of the consumer credit though is new instruments. I think they are fairly straightforward instruments, like mortgages, which have been around for some time. The proportion of fixed rate mortgages might be rising, but I do not think the broad shape of the instruments is very different. We do worry, and we look at it carefully, but, as you will see in our May report, I think we take a slightly central view, and I am, as I say, keen not to be painted into either corner, either believing that this is all necessarily going to end in tears tomorrow or that there is no reason for concern. I think, as I have indicated, the longer it goes on for, both in the mortgage market and in the general borrowing market, if the current rates of growth continue, the adjustment will be quite severe. Our own central projection is for a gradual slowdown in the inflation rate.

  111. One of the figures that is in the May Inflation Report and is specifically referred to in the minutes of the MPC is the growth in unsecured lending to individuals, which grew by 15 per cent. Do you have any concerns about the impact of that on financial stability? Could it have an impact on financial stability?
  (Mr Clementi) It clearly could, and that is why my cautionary comments are directed as much to those who are doing the lending as to those who are borrowing. One hopes very much that their standards of credit criteria, their credit scoring measures, are not weakening in any way. We have just been through a round of results from the UK banks, and profitability, return on equity, is slightly down this year. That is largely to do not with their main operations but through greater provisions, so they will be on notice of this. Having said that, our overall analysis is that the UK banks remain well capitalised, certainly by reference to any historical or international benchmark.

Mr Laws

  112. Mr King, can I take you back to the MPC's meetings this year and the decision making process. At the MPC meeting in May, the first paragraph expressing views discusses those members who are worried about inflation projections moving up and the possibility of the pound falling, which is now beginning to happen, concerns which have been identified with you in the past, yet in the past couple of meetings you have not voted for a rate rise. Why have you not voted for a rate rise?
  (Mr King) I think the May minutes make it fairly clear that there was a difficult judgement to make and that overall there was a unanimous view that although the forecast did suggest that if events were to turn out exactly as the central projection, a rise in rates would be necessary at some point, that time had not come, because the central projection for inflation was below the target for most of the two-year horizon, and it is only right at the very end that it was starting to pick up above the target.

  113. Do you personally think that we are pretty close to needing to increase interest rates?
  (Mr King) I am not going to comment on the present situation. We are here to discuss the May minutes and the May Inflation Report. The judgement in May was a unanimous one that although there was an issue to discuss, the time had not come for a rise in interest rates.

  114. After the Committee makes its decisions, which are obviously reflected in the minutes, you then chair a press conference following all that, and you set out there some comments of your own about the view of the Committee and the views of the Bank. How do you ensure that the views that you are putting forward in that report, which is obviously widely reported in the press, reconcile with the views of your colleagues?
  (Mr King) Because I follow the agreed text of the Inflation Report almost exactly. If you look at the text of my speaking note, you will see that it contains all the points identically in the same order as the key paragraphs of the Overview. The Overview section of the Inflation Report is agreed by the Committee as a whole on the Friday before the press conference, and that is agreed word for word, as indeed section 6 of the Report is. The press conference is not there to explain the minutes or the decisions as such; it is there to explain and elaborate on the Inflation Report, and that is what I do.

  115. When we saw our advisers earlier on this week, we saw Roger Bootle, who you obviously know. He said to us, "I happen to know that some MPC members have on occasion been somewhat surprised, as it were, by the tone taken at the MPC Inflation Report press conferences." I asked him, "Do you think they were surprised by this particular conference or not?" and he said, "I think it is possible that they were." Have you been aware in relation to this press conference or previous press conferences of any concern amongst MPC members about the tone that you strike compared with the views of MPC members?
  (Mr King) No. I am surprised Roger said that. I have a high regard for Roger, but on this occasion I think he is way off beam. No-one has ever said that to me at all, either privately or in a meeting of the Committee. Indeed, they tend to say the opposite, which is, "Rather you than me." On this occasion I think what people picked up on and discussed was what some people thought of as a difference between the tone of the Inflation Report and that of the minutes. That is a quite different issue. The press conference is there to explain the Inflation Report. But again, I think that view was a mistaken one, because we have tried for some time to point out that there is no mechanical link between the central projection exactly two years ahead and the policy decision. As I said at the May meeting, I think that the forecast we had in May was consistent with a range of different decisions. There cannot be a simple mechanical link. What the forecast does is to raise the key questions for the Committee, and the judgement of the Committee comes to the fore. Certainly I have not been aware of any concerns of that kind at all.
  (Sir Edward George) If I could just intervene, Chairman, I have to say that I have not been aware of any concerns. No member of the Committee has raised this with me. I would have thought it was more appropriate for them to raise it with me than to raise it with Roger Bootle, so I would not attach too much importance to it, frankly.

  116. Coming back to the question the Chairman asked at the beginning, when you gave your briefing after the May MPC meeting, you put in your concluding paragraph the sentence that although the Committee had agreed to leave interest rates on hold, "it stands ready to counter building inflationary pressures as and when they emerge." What was your intention in including that sentence?
  (Mr King) To repeat what was in the Inflation Report. As the Chairman said, that sentence appears in the Inflation Report.

  117. What was your expectation of the effect that that would have on the financial markets?
  (Mr King) I did not go into it with the intention of trying to manipulate or influence financial markets. I went into it with the intention of trying to explain the views of the Committee as expressed in the agreed draft of the Inflation Report.

  118. You will be very well aware because of your experience in these matters that this is the kind of wording that is used by other central banks, including the Federal Reserve in the US, when it wants to indicate that a committee which has been having a view of no change in rates is moving towards a bias to believe that it may be on the point of moving rates in a particular direction. Were you not concerned that the financial markets would conclude from this that the Committee is very close to coming to a decision to increase interest rates?
  (Mr King) With respect, I do not accept the premise of that question. It is not true that there is any single method of wording which the Fed has used consistently to indicate that it either does or does not have a bias. Indeed, the Federal Reserve has changed several times in recent years the wording of its statements in order to change the way it indicates bias. We have never had and do not have a concept of a bias, and there seems little point in having one. We look at these decisions afresh every month, and the Committee does not collectively sit round and spend time trying to work out what we might do in a month's time. There seems little point in doing that because we know that by the time we get to our next meeting there will be new data that we cannot predict now, and there seems little point in wasting time doing it.

  119. Mr King, what you say at a press conference, particularly in the section that deals with the conclusion that the Committee came to, is incredibly important, is sensitive and will be looked at very carefully.
  (Mr King) Yes, and I say at almost every press conference I have given for over ten years now that we do not speculate on what decisions we will reach in the future, and I make quite clear that I see no point in doing so. What I am trying to do is to explain the outlook for the economy as the Committee currently sees it. It may well be different in another month.


 
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