MR MERVYN KING, MS RACHEL LOMAX, PROFESSOR CHARLES BEAN, DR ANDREW SENTANCE AND PROFESSOR DAVID BLANCHFLOWER

26 MARCH 2008

  Q40  Mr Love: Can I take you to back to a comment you made earlier on. The Economist over the weekend did a piece on financial markets and the plea at the end of this article was, "Don't re-regulate". What is your view about the impetus that there will undoubtedly be because of what has happened at the core of the financial system to increase regulation?

  Mr King: A brief answer would be do not have knee-jerk reactions but think very, very deeply about the causes of this crisis and whether levels of bank capital and the sort of financial system that generated this crisis does not require some action.

  Chairman: We will probably be asking you that later on in a month, Governor.

  Q41  Nick Ainger: What is your outlook for business investment?

  Mr King: Let me ask Professor Bean to pick that up.

  Professor Bean: As I said earlier in response to Ms Keeble, we have slowing investment in the projection which is in part down to slowing residential and commercial property investment. There is also a wider slowing of business investment reflecting the reduced availability of credit and the general deterioration in growth prospects. As compared to where we were in November, we see the recovery from that slowdown in investment to be rather more muted and that is one of the reasons that the growth profile in the February projections is weaker than we had in November.

  Q42  Nick Ainger: But if you set aside property, what about the rest?

  Professor Bean: I mean there is a slowdown in business investment. We have had relatively high rates of investment growth over the past year. Investment intentions have come off a bit but they are still at a reasonably high level, so there is no sign yet of business investment falling sharply. There are indications from our Credit Conditions Survey that the availability of credit to corporates is declining. It has not shown up yet in corporate lending but that is probably because it takes a bit of time. Businesses often establish a credit line with a bank and then run it down. Then they go to the bank at some stage in the future and say they want some more money and at that point the bank will say, "No, we will not extend your line further". So through the course of this year we expect to see the rates of business investment growth coming off noticeably.

  Q43  Nick Ainger: A substantial amount of public sector investment is now through PFI and obviously significant credit lines are required for that. Do you expect to see that PFI projects are now either in jeopardy or the actual price to the taxpayer is going to substantially change because of the credit squeeze?

  Professor Bean: I would think it is entirely plausible that companies would be less willing to bid for PFI projects or that the terms that are offered would be less attractive to the public sector, yes.

  Q44  Nick Ainger: The United States has been one of our sources of inward investment. Do you expect that the American economy will be retrenching and not seeking to carry out any further major outward investment into this country or into Europe as a result?

  Professor Blanchflower: I think that is a good way to characterise it. Certainly the feeling we have now is that is true and if you go back to your question about the public sector, certainly in the US now the public sector is having a lot of trouble with municipal bond rates that municipal authorities are having to pay that are extremely high. A good word is retrenchment. The data on the last two days suggests the economy is slowing fast and despite all the things the Fed are doing it is trying to play catch-up and investment from the US outwards is going to be restricted. I certainly think the US looks that way. That has changed a lot in the last two weeks.

  Q45  Nick Ainger: What about other countries, Japan for example? Presumably, as the Governor said, this is a global problem affecting all financial centres. Is Japanese industry taking the same view that American industry is doing in terms of outward investment?

  Professor Blanchflower: I do not know, maybe Charlie can help.

  Dr Sentance: Perhaps I could make a comment here. We need to make a distinction between the financial sector and the pressures there, though clearly the financial sector is an important part of the economy and more general business investment trends. The UK has historically been very open to inward investment and has drawn investment across the business sector as a whole from a wide range of different countries and regions. As long as the business climate in this country remains reasonably sound, we keep low inflation and the micro side of the economy is functioning well, I would expect that to continue. The sources of that business investment may shift around, and we have already seen quite a shift. We now see Asian companies, Indian companies, Chinese companies investing. The most important thing for inward investment is the business conditions that we have here, that they remain stable and the functioning of the micro economy remains attractive to that investment.

  Q46  Mr Brady: Governor, you forecast a marked slowing in output growth through 2008, but that growth will subsequently recover as credit conditions improve and lower interest rates and weaker sterling work through. When do you expect that recovery to begin?

  Mr King: Well, in the projections that you see in the February Inflation Report it is later in 2009, but no-one can know precisely what will happen. Even there we do not have growth coming right back to what we might think of as trend. It is a pretty slow pick-up. There is now a period of slower growth and then a gradual pick-up, not a sharp bounce-back.

  Q47  Mr Brady: Has that expectation of picking up from February shifted in the last few months, the last couple of months?

  Mr King: Last couple of weeks! We have not been through another round where we could consider all these things. This is still the default picture on the table in big terms. We will come back to it again in May.

  Q48  Mr Brady: You have already spoken about the marked difference between the real economy and the financial sector and clearly the slowdown at the moment has been more concentrated on the financial sector and retail. Are there other sectors of the economy that you would say are particularly vulnerable?

  Mr King: Property, both residential housing and commercial property. I remember when we came here last to discuss the Inflation Report in November, I think, Chairman, you asked us each to nominate our one risk that we were worried about on the downside for the UK and I said then commercial property. I think you can see pretty sharp falls in prices of commercial property. There is quite a dramatic chart in the Inflation Report which shows the fall in commercial property prices. There clearly is a risk there.

  Q49  Mr Brady: Anywhere else?

  Mr King: Property and finance are the two areas which stand out to me as being the ones which are the weakest at present.

  Q50  Mr Brady: Thank you. Can I turn to Professor Blanchflower and ask what your assessment is for the outlook for the labour market over the next six months in the UK?

  Professor Blanchflower: In a way the surprise has been the resilience in the quantities that we have seen in the last two or three months. I perhaps had not been as confident that they would have remained as strong as they have done, but there are weak points in it, especially if you look at the total number of hours. We have seen total employment in the last numbers rising but total hours fell, so there are points of strength. The survey data that we have seen have been somewhat softer, so the Agents Reports about recruitment and the number of staff they are going to maintain and the KPMG more recent reports on jobs have really been quite weak. I feel that we are at somewhat of a turning point and it certainly appears in the wage data that weakening has come even further. There has been some strength in the past with bonuses and those seem to have come off a little as well. My view is that we are probably at some degree of a turning point with some weakening coming, but quite where that will be I am unsure. It seems to me there is going to be weakening coming, I do not see any obvious surge in wages currently. I am not particularly optimistic about conditions in the labour market but it has been quite resilient and that has been a surprise. The concern to me is, despite that, we have started to see a decline in hours and that might just be the indicator of the turn.

  Q51  Mr Brady: So the turn might now be that we would start to see the total number of people in work starting to fall?

  Professor Blanchflower: The obvious thing one would be looking at would be what is happening to total employment, what is happening to hours, what is happening to unemployment, what is happening to the claimant count. I am going to focus on part-timers: "Are you taking a part-time job because you cannot find a full-time job? Have you got a temporary job because you cannot find a permanent job?", and has non-participation risen. That is one of the big things we have seen in the US, that despite the fact the unemployment numbers fell there was a huge increase in non-participation. This is a time to focus on a large number of components of what is happening in the labour market. The headline I have in the KPMG report is the smallest increase in 50 months and declines in every one of the sectors. How far it will go we will see. It has been resilient, we will see as we go forward, but weakness coming is what I see.

  Q52  Mr Brady: How much of any reduction do you see being absorbed by reduction of levels of inward migration?

  Professor Blanchflower: I have tended to not like the word "migration", I prefer "people who have come from Eastern Europe" and I have written some stuff about that. In fact, in the latest numbers when you ask the people who have come from Eastern Europe, "How long are you intending to stay for?", only 8% say, "I intend to stay for more than a year" and about 60% say, "I intend to stay for three months or less". This is a question we are going to have to think about. There are three things that matter really: the number of people who are coming from Eastern Europe, how many times they are coming in a year and how long they are going to stay for. These are things that are hard to forecast. It looks to me that those numbers are relatively strong. The other thing to question is what is going to happen to wage levels and GDP levels in the donor countries because the relative gap makes a difference. If we see some slowing and they see some strengthening then you would expect to see those flows falling. That is what you would expect. These are tough times, we have only really seen this since 2004, but you might expect to see some of the slack being taken by those folks going back.

  Q53  Mr Brady: If they start to stay at home, stay in Poland or wherever instead of coming here as often or for as long, does that have an effect in helping to cushion any reduction in wage rates in this country?

  Professor Blanchflower: I would think particularly it might cushion any impact on unemployment. If the shortage means those folks are going back to Eastern Europe it might dissipate any effects on unemployment. This is a sign of a flexible labour market and why wages have kept low is because of the flexibility we have here. We will see, I will try and keep you posted. I will come back later and tell you what has happened.

  Chairman: There is always a welcome here!

  Q54  Mr Dunne: Governor, in your opening statement you highlighted early on the increase in food prices in world markets, I think you said up more than 50% on a year ago, and also oil prices two-thirds higher than a year ago, yet very little of this seems to have been reflected in the historic data to date, at least on the CPI measure of inflation. How useful is the CPI as a measure of inflation for households?

  Mr King: I think it is useful. You can always quibble about precise definitions. The impact on food prices can be seen in the CPI. The inflation rate for food in that index is running at a much higher rate than it was a year ago and we would expect to see more of that coming through. On energy prices, the issue there is that the behaviour of domestic gas and electricity prices has been rather different in the UK than on the Continent and the impact of higher world energy prices has come through more quickly there than here, but we are clearly seeing that now. You saw it in the February inflation number, up from 2.2 to 2.5, and we would expect that to rise markedly in the next few months. I think it is coming through now.

  Q55  Mr Dunne: You say in the February Inflation Report that you are expecting just under half a percentage point increase in CPI as a result of the January and February gas and electricity price increases which, from memory, were of the order of 15-20% for households.

  Mr King: 15.

  Q56  Mr Dunne: 15, thank you. If households are seeing their energy bills going up by 15%, and that is in the last quarter, and there were increases last year as well, food prices are not being passed through directly at these very large commodity price increases but the Inflation Report talks about a 6% annual increase in food prices which, again, I suspect is a lagging indicator. Perhaps you might comment on that.

  Mr King: Part of that difference, of course, is that when you buy food in a supermarket only a fraction of the cost of it is attributable to the raw materials.

  Q57  Mr Dunne: Indeed, but are you anticipating significant increases in household bills as a result of the food and energy increases that we have already seen? Do you think there is risk on the upside to the inflation target as a result of these two factors?

  Mr King: In the short run, yes. We say our central projection is to rise to about 3. It may well go above 3, who can be sure. A lot will hinge on the degree of pass-through of some of the costs that firms choose to make. As I said, we have talked about these two very big risks and identified one from the housing and demand sector which will impact on inflation on the downside looking further ahead if it happens, but the other risk, of course, is if the short-term rises in inflation start to colour the expectations of people about where inflation will stay in the medium-term, that will have quite a serious impact. These are two big risks, they are both important, and we have got to take both into account. You are right in highlighting that risk, it is a risk.

  Q58  Mr Dunne: Professor Blanchflower, that takes me on to the impact that this might have on wage inflationary pressures, which the Governor was just alluding to there. Do you see this as a significant risk in the short-term?

  Professor Blanchflower: Obviously it is a risk in the sense that people's living standards are being impacted, their real wages have been relatively low and prices have been rising, but it certainly does not appear that this is a point where people's bargaining power is going to be substantial, so obviously people are going to feel the hit in some sense when they have not had significant wage growth, tough times are here. Obviously we will keep track of it but it certainly does not look as if this is a time when workers are going to be able to bargain and get large, substantial increases, they need to be mindful of the fact that they need jobs.

  Q59  Mr Dunne: So the conclusion of the Committee, if you are speaking for the Committee, is that we are going to go through a period of tightening take home pay this year?

  Mr King: I think that is broadly the view. We have seen pretty low growth rates of real disposable income over the past year too. This is because we cannot insulate ourselves from what is happening in the world. When oil prices, energy prices, food prices are rising, as a country our standard of living is going to rise much less quickly than it would do if those rises had not occurred. On the bright side, looking forward the inflation rate will fall back and the growth rate and living standards will pick up again provided food and oil prices do not go on rising as fast. They do not even have to fall, they merely have to not rise as quickly as they have been doing for the inflation rate, other things being equal, to come back. As we say, the risk is if firms and those involved in pay bargaining start to think that the way we react to inflation is to take less notice of inflation than we have been doing in the past then they may say, "Well, actually we can afford to be a little bit more relaxed about the pay increases we agree to because general inflation will take care of it", and we cannot afford to get back into that culture of the 1970s and early 1980s where people felt, "Well, we can take gambles with what pay increases we agree and demand because in the end the government will give in and allow inflation to rise to validate those decisions". We cannot do that. We have to try to ensure that we are in a climate where people feel that, yes, we are looking at activity because it affects the outlook for inflation but we are not going to lose control of inflation in this country.