Examination of Witnesses (Questions 60
TUESDAY 11 JUNE 2002
60. It is possible but not likely?
(Professor Miles) The reason I am hedging is because
I think we have no good stories as to what has happened to the
sterling exchange rate for at least the last three or four years,
and possibly no good story for a much longer period. To sound
more confident than, well, "that is a possibility",
just overstates one's knowledge.
61. If I could just pick up the point made by
David Walton earlier, that traditionally the pound has moved in
correlation with the dollar, there is a very interesting chart
1.20 on page 10 of the Inflation Report which appears to
show that over the last nine months there has been a significant
change in market expectations; and that the market now appears
to expect the pound to move much more strongly correlated to the
euro than correlated to the dollar. If that is correct that would
certainly be a significant factor in euro debates. Do you think
that is correct?
(Mr Walton) With all due respect, when you have only
got 18 months' worth of data on a chart you have to be a little
bit suspicious of the chart. I do not think this chart proves
one thing or another. It certainly does show, as you say, in the
most recent period a slight change in correlation. I would very
much like to see this chart going back a few more years.
62. Are you saying this particular chart is
misleading, and you do not think this reflects a change?
(Mr Walton) It is not necessarily misleading, but
I think it is a bit much to draw any strong conclusion on what
is a relatively short period of time. There is no reason over
time why the pound has to be correlated one with the other. If
Britain joins the single currency clearly at some point the correlation
between the pound and the euro will go to one; and the correlation
with the dollar is going to drop quite a bit. Indeed, during the
ERM period these correlations change quite a bit. Ultimately a
lot depends on the relative economic conditions in the UK versus
the US versus Europe. It is very difficult, looking at any chart,
to really infer too much about the future.
63. Might this not reflect a hedging of market
bets in view of the increased possibility that we would be joining
the euro if those people are edging towards one market?
(Mr Walton) I think it would be interesting to extend
this chart to cover the most recent period, bearing in mind that
the pound was quite stable versus the euro until a few weeks ago
when the euro suddenly started to recover. I suspect that the
correlation of the pound with the euro has actually fallen back
quite a bit in recent weeks.
64. Could I ask the witnesses about a comment
that Sheila Dow made to us. I am sorry to go back to housing again,
but she said in her note that much of the price increase is due
to speculative activity in the market. Could I ask all of you:
can you think of any ways in which the Bank and other economists
could assess at the present time how much of the price increase
and how much of the activity in the market is speculative rather
than simply because we have got very low interest rates?
(Mr Bootle) It is very difficult to pin down the term
"speculation". One is tempted to say one could do it
by looking at things like the degree of overseas investor interest
in UK property, the extent of the buy-to-let market and so on.
Frankly, I do not think that does really get to the nub of the
question of speculation. After all, the UK owner-occupier who
increases the size of his mortgage and trades up can be just as
"guilty" of speculation as the overseas investor. Speculative
activity can drive the ordinary parts of the market. Indeed, I
think it is characteristic of the housing market that this does
happen. It is precisely what occurred at the end of the 1980s
boom, where people brought forward their purchases; they moved
up; and people who would not normally be in the housing market
pre-empted their potential future need for housing by jumping
in because they were anticipating future gains, or they were fearful
of being shut out of the market if it carried on rising at the
65. Some of that could be an enduring factor
as a consequence of people anticipating these low interest rates
would endure. Many of you would probably think they are going
to. One needs to distinguish between that and more obvious speculation.
(Mr Bootle) I do not know how you begin to do that.
You could always conduct various surveys but I do not think they
would get you very far.
66. Sheila, are you a bit unhappy with the definitiveness
of your statement?
(Professor Dow) No, I intended to use the word "speculation"
in the broader sense of the wordI just used it. There is
clearly a core speculative market in the buy-to-rent market, but
there is speculation much more generally. Unfortunately, the evidence
is somewhat patchy but there are various pieces of evidence of
households being over-extended. This is why I suggest it would
be useful to have a disaggregated set of data on debt/earnings
ratios. Because of anticipation of capital gains households are
over-extending themselves and leaving themselves very vulnerable.
(Mr Walton) I think "speculation" is a difficult
word actually. I would not characterise what Roger said as speculation.
If somebody thinks they need to get into the housing market now
because if they do not the prices are going to be running away
from them, which is my experience of the late 1980s, that is not
speculationthat is just fear that they are not going to
be able to own their own house in a property owning democracy.
Clearly there are some elements of speculation at the margins
and it gets exacerbated by David's point earlier, which is that
the supply is largely fixed; and if you suddenly get people being
more active when the supply is fixed then that tends to push prices
67. Impossible to measure that speculation?
(Mr Walton) Absolutely.
68. In the very interesting discussions we have
had this morning it has been quite clear that you all see great
uncertainties about the growth, great uncertainties about house
prices, indeed some rather confusing signals from the MPC about
how those issues should be addressed. Do you actually think that
the risk of a major period of economic instability, and a real
test of the margins of the strength of the financial sector, is
greater now than it was a year ago?
(Mr Walton) I always think there are uncertainties.
69. There are always uncertainties, but are
those uncertainties greater now than they were a year ago?
(Mr Walton) If you go back to when we had the Asian
crisis and LTCM, that also posed some risk and uncertainties to
the financial systemperhaps more globally than the specifics
of the UK housing market now. Banks generally are very well capitalised
in the UK. The notion that there is much danger of systemic risk
to the UK financial system I think is pushing it a bit at the
moment. I guess the risks are a bit higher now than they were
a year ago, just because house prices are that much higher and
look overextended. There is some risk you would get an increase
in bad debts. I personally would not think there is much danger
to the real health of the financial system presently.
(Professor Miles) I do not think it is so much a danger
to the financial system, if one means financial institutions.
I think it is more of a risk to parts of the household sector,
where you come back to the whole discussion about the implications
of a rise in interest rates with so much more household debt than
there was even a year or so ago. I think the danger is more for
distress within parts of the household sector, rather than distress
amongst financial institutions.
(Mr Bootle) I think I largely agree with that, although
I probably am more inclined to answer, yes, to your question about
is the outlook more uncertain than it was. Putting aside considerations
of September 11th and so on, from a purely UK point of view, I
think what makes it rather more uncertain is that we may be at
the beginning of the process of the unwinding of the imbalances
of the last couple of years. For some while now there have been
some fixed points in uncertainty, namely, we have had a strong
pound, and we have had a very strong consumer sector. Much of
what we have been talking about this morning is about those two
things perhaps changing at the same time for not totally unrelated
reasons. Certainly if we get a much weaker exchange rate then
I guess the MPC will feel inclined towards a higher interest rate.
Indeed, a weaker exchange rate will itself bring processes to
bear on the consumer, because it will tend to increase the price
of goods in the shops. We have then got tax increases coming from
the Chancellor and higher interest rates as well, and house prices
are not performing as they have done. You can see circumstances
in which the consumer is under pressure on several fronts in a
way we have not seen for a long time. I do not think it is surprising
or inconceivable to imagine a scenario in which we have a period
when consumers in general go through a very rough time. Given
large parts of the economy have been doing pretty well on the
back of strong consumer spending, I do not think it will be surprising
to find some parts of the economy, not just banks or lenders but
also retailers, having a very difficult time. My experience, talking
to companies over the last year or so is that, by and large, people
at the retail end have not appreciated (just as they did not at
the end of the 1980s) the extent to which they have been through
a fantasticly favourable macroeconomic period. They think it is
all to do with the brilliance of their product or their sales
marketing process or whatever it might be. They do not realise
that they have had it really very, very comfortably indeed because
of macroeconomic circumstances.
(Professor Dow) I would add, there are elements of
systemic risk at the moment which were not present earlier on,
and we are talking about currencies and the relative absence of
safe havens for savings. There is a lot of uncertainty globally
which affects UK markets. Within the UK economy, if you look at
regional economies, there has been a very different experience
in different parts of the economy. There was an interdependence
between earnings experience, employment experience, house prices,
expenditure and monetary policy which is geared to another type
of experience which can hit that kind of situation rather badly.
The Bank of England has been quite sensitive to that in the past,
but this is a particularly difficult time, in that we do not know
the future of house price inflation at the moment. It may be that
the Bank will feel it has to act on interest rates in a way which
will have a systemic effect on particular pockets of the UK economy.
(Mr Walton) There is one very big difference with
the late 1980s which is that the UK economy was very substantially
overheating. The risk that interest rates have to double, which
they did essentially between May 1988 and late 1988, the risk
of that is so much less these days, so much that you are unlikely
to put in place these very severe adjustments in the housing market.
Chairman: On that reassuring note, thank
you very much for your appearance this morning. We will be better
informed on Thursday when the Governor and his colleagues come;
and no doubt the Governor and his colleagues will be better informed
through his emissaries who are here this morning reporting back!
Thank you very much.