Order, order. Welcome to the Treasury Select Committee on Tuesday the 19th of November 2024. Today we're delighted to welcome the Governor of the Bank of England and members of the Monetary Policy Committee to give evidence to us as one of their regular outings in front of us. Of course, rate setting took place recently, and there will be another one in December. So I'm delighted to welcome Andrew Bailey, the Governor of the Bank of England, a regular visitor to this committee, joined by Clare Lombardelli, the Deputy Governor for Monetary Policy and a member of the MPC. And they're joined by Dr. Catherine Mann and Professor Alan Taylor. And a special welcome to Professor Taylor because, of course, he became a member of the committee just after we were all elected, so hasn't had the normal meeting in front of us on his own. So this is your chance, Professor Taylor, to get to know us and for us to get to know you and to hear your thoughts on all of these issues. And I wanted to dive straight in, if I may, to those of you who voted to cut rates. So Dr. Mann, I'll come to you in a moment, but you know, what tipped the balance for you in terms of cutting rates? Perhaps we can start with the Governor.
Yeah, thanks, Chair. So the starting point for me was that the pace and progress on disinflation, on bringing inflation down, has been faster than we expected it to be. And that actually has been true not only over the last year but actually been true in the intervening period between our August report and the November report. And so we were starting at a point where we were lower than we had expected to be, which is obviously good news. So that influenced my thinking. But obviously, you don't have to get behind the why is that happening and what are the risks around it. And so I would put this into a little bit of context, if you don't mind. I think we cut rates, but we also, as you might have seen in the language, emphasised the word 'gradual' looking forwards. So on the one hand, my vote was very much, as you say, reflecting the progress I thought we'd made over the recent period. But then against that, I think we have to balance two things, which I'm no doubt we'll come back to. One is the fact that if you look at the components of inflation, the sort of the more domestic component, particularly services, is still above a level which is incompatible going forward with us being on target on a sustained basis once some of the shocks that are still affecting things like energy sort of wind through. So we have to watch that very carefully. That quite clearly reflects developments in the labour market, which no doubt we'll also come on to. So that's the first thing. And then the second thing is that there are a number of, you know, risks out there which we'll also no doubt come on to, so I won't say much about them at this stage. But, you know, UK import prices have been stronger than would be indicated by world export prices, that's put some upside on. And then we're obviously looking at things like the impact of the budget, which I don't doubt we'll come to, and developments in the world at large. But put all of that together, I felt that the progress that we'd made and the fact that what we were seeing in the inflation outturns justified us taking another step. Obviously, it was our second step; we made the first one in August.
Okay, well, interesting the word 'gradual', which I'll come back to, I think, in a moment. But Ms. Lombardelli?
Yes, thank you, Chair. So the dominating factor for me was what we've seen in the data on inflation following the disinflation that we've seen, and perhaps more importantly, the drivers of inflation. So we are seeing and have seen a fall in services inflation. We are seeing and continue to see a fall in wages, wage settlements. So you take that together on top of obviously what's happened to goods prices, and if you take that together, that suggests that the drivers of inflation are less strong than they have been in the past. But similar to the Governor, and perhaps we'll come on to this, I kind of see risks on both sides. So again, it felt right to slightly lift the level of restrictiveness of monetary policy at this time, but looking very carefully at the data that we are expecting, and in particular looking to what we're expecting to get over the coming months. For example, our agents will be talking to businesses around the country and doing their pay survey, which we'll get the results of early in the new year.
Thank you, Chair, and thank you for your welcome. Yes, I'm broadly in agreement with what the Governor and Clare Lombardelli said. I think there has been progress. There was reason to be cautious, I think, six months or a year ago, but the unfolding data is, I think, in line with historical patterns if we look at the evidence across countries and across time. I'm doing some research now with my team at the bank, and there's a general pattern which is energy shocks will feed in very quickly to some sectors, they'll feed into goods, they'll feed into food, but they'll feed in more slowly and peak later when it comes to services and wages. So in the broad scheme of things, I think the pattern is unfolding as you would expect. It's not abnormal, but you want to see some reassurance as you go through those phases to see that it is proceeding normally. You're worried about the case where inflation maybe persists longer and you'd be worried about expectations becoming unanchored. We'll get back to those cases later, and there was, to put quite a lot of weight on that, probably six to 12 months ago. But as the Governor said, the numbers keep coming in a little bit below where we thought we would be. So in my mind, that was shifting weight, well, even before I joined the committee, in my mind towards a more normal scenario, and that gave me reassurance to think it's okay to continue with the gradual pace of cuts which had started in August.
I'm hearing the word 'gradual' a lot. Dr. Mann, you didn't vote with your colleagues at the table, so what tipped you the other way?
Thank you very much, Chair, for the opportunity. We all do look at the data very carefully, and I look at the data in a slightly different way. I do agree that the 1.7% CPI headline inflation was below where it was expected to be last August, but that was principally, almost entirely, due to changes in the energy conditioning assumption. If we look at the underlying components, whether it be goods, services, or wages, we missed by quite a bit less. And in fact, for wages, we underestimated wage dynamics in our August NPR. So I look at that, and then I add on the observation from our Decision Maker Panel that looking forward, they give us a steer on their expectations for prices one year ahead, and for consumer-facing firms, it's still over 4%, where for historical comparison, it needs to be at least 2%. Similarly for wage expectations, and this was before the budget, for consumer-facing firms, wage expectations are 5%. Now, it is also the case, again looking at our Decision Maker Panel, that there has been deceleration in both forward-looking prices and forward-looking wages for a number of months earlier on this year. But for both of those categories, in general across all firms, there has been no continued deceleration for four months. In other words, these forward-looking prices and wages have been flat above target-consistent, or historically consistent, rates for four months, and I take that as indicative of a concern about the persistence of embedded inflation lasting for longer. Household inflation expectations also have ticked up, not in an unanchored way, of course, but nevertheless ticked up as opposed to continuing to decelerate. For the Citi expectations, for four months it has been ticking up, and for the Ipsos, it also ticked up in the Q3 data print. Finally, I do take a steer from financial markets. From their point of view, inflation expectations, we would not, at the current pace associated with the conditioning assumption that we have in the forecast, we would not get to a 2% sustainable headline inflation within the forecast horizon. I also did take some, I did incorporate two aspects of the budget in my consideration. I made the observation, which of course was incorporated in our projections as well, I took the consideration that it was front-loaded, that it was front-loaded on demand, and that it was geographically dispersed throughout the economy, which all of that is a good thing from the standpoint of the pace of economic activity in the economy. But it does also offer the opportunity for firms to realise the price increases that they have an expectation going forward. Again, those are inconsistent with a 2% target, and we can discuss other elements of the budget with regard to the National Living Wage potentially coming from the Low Pay Commission.
I was going to ask, what account did you take of the increases on wages in the budget, of National Minimum Wage and a potential increase of some of the employer insurance contributions?
In my analysis of labour market conditions, as it is reflected through current wage developments across different types of firms and on expectation, as I noted from the Decision Maker Panel and from our agent meetings, there is a residual or legacy effect of the two increases in National Living Wage over the last two years, which even before the budget, firms were struggling to incorporate that and deal with that in the sense of a wage compression problem throughout the ranks of their firms. They were deciding how were we going to handle... you're talking about differentials here?
Differentials across different job categories within a firm, that there was an inflationary pressure up the chain, but they were going to have to figure out how to deal with that because they had not incorporated all of the... there was wage compression based on two years' worth of uplift in the National Living Wage. Again, that's not a bad thing to have an uplift in the National Living Wage, but it does create this situation facing firms of wage compression and how they were going to deal with it. That is accentuated by the prospect of a higher than inflation... a prospect for a higher than inflation increase coming from the Low Pay Commission remit in February, April next year. Then again, there's also the increase in the National Insurance contributions, which again firms will have to address. Now, we talked about this in the Monetary Policy Report. There are a number of different ways that firms can adjust in the face of National Living Wage or National Insurance contributions. They can pass it through to prices or try to do that. They can incorporate, you know, they can just keep wages, make that be the manner in which the adjustment is made. Those have different implications for profit margins. They can also have the margin of adjustment of reducing the number of people they employ, or they can engage in investment that would be productivity-enhancing. Those are all different ways in which firms can meet these challenges within their overall budgets and their objectives, what they want going forward. My view is that we need to wait and see how these... all of these are upside risks to inflation, both wages and prices that already were stagnant at target-inconsistent rates, and that we needed to wait and see how these were going to materialise going forward.
Okay. Can I go back, perhaps, to Professor Taylor first? A lot of you talked about gradual approaches. How quickly do you think rates are likely to fall, and how fast would you see the pace of cuts? That's the question on everyone's mind. But 'gradual' is one of those words that means different things to different people, and I think one view in the market is gradual means a cut every other meeting, and aggressive means a cut every meeting. But of course, in the course of a year, there are eight meetings, and we don't only have the choice of doing zero, four, or eight. So there's a wide range of possibilities going forward, and that depends on how the data unfold.
I mean, my view is going forward, for some of the reasons we've alluded to, the key is going to be the labour market and what do we see there. It's going to be very important to keep an eye on that. We don't necessarily have the best statistics there, which we'll probably come back to, but we're going to have to take a lot of reads from different sources, including crucially our agent network. But I think if you ask what does 'gradual' mean right now, it's aligned in our case too closely to the market curve, so that would be in line with about 100 basis points over the next year. So I think, you know, just to align with the conventional interpretation, we should try to stick to that. But that doesn't mean to say that's what will unfold. If conditions are weaker, and my own view is skewed to the downside risk now versus the upside risk of about a year ago, then we could go faster.
Okay. Ms. Lombardelli, what market conditions would you need to see to go faster?
Well, I mean, I would say it's not really market conditions as much as, in terms of financial markets, it's the broader picture for the economy that I'm looking to. And in particular, looking at, you know, it's very hard to sort of judge these things, but the level of demand and potential supply in the economy, what that means for firms' ability to raise prices, you know, what we see on costs, so what pressures we're seeing there, and what's going on on the sort of supply side of the labour market in terms of capacity. There's a lot of uncertainty around all of that, but those are the sorts of things we would look to. As I mentioned before, particularly interested in things like what are we picking up about expectations for next year around pricing and around cost drivers, particularly in the service sector where, as others have said, we have seen and we are seeing inflation coming down, but to rates above target. So those are the sorts of data I'll be looking to in making those decisions.
And how long do you think it will take for some of these things to feed through? Because, you know, we've got snowing today, there's lots of other international things.
I mean, as mentioned, we're making policy thinking about how the economy is going to evolve over the coming months, year, two years, three years. It's important, you know, it's snowing today, but, you know, and the weather plays a factor, but I wouldn't put too much weight on the very short term. I think we will get quite a lot of information in the sort of early next year on what's happening in the labour market. There's a lot of uncertainty, as others have said, for a whole range of reasons. You know, some of that is about policy, but actually a lot of that is about how is the labour market responding to the big shocks we've had over recent years, particularly COVID, but others. What's going on cyclically in the labour market? But, you know, we will be looking quite carefully at things like the data we get from our agents around wage expectations for next year, what we're hearing from businesses around the country about how they will respond to things like NICs and the National Living Wage. Certainly, when you go around the country and you talk to businesses, what happened last year on the National Living Wage is a pressure, as Dr. Mann says, that comes up probably more than any other issue, actually. So I think we will get quite a lot of information early next year in particular around what's going on on some of those uncertainties. But look, there's a lot of uncertainty out there, and I've no doubt next time we'll say it's all very uncertain.
Governor, I'm sure you've got some comments there, but one of the other issues is because some of the budget policies won't have an impact until April next year. So when you talk about 'gradual', are you, presumably, you're playing those factors, how policy will hit the labour market, into your thinking?
Yes, I mean, I agree with a lot of Catherine's assessment, by the way. I think there is some evidence of some loosening going on in the labour market at the moment. Our agents tell a slightly different story to the Decision Maker Panel, but you're right, I think Catherine laid it out. One of the important elements of the budget for us is how this increase in the cost of employment then plays through. This is really probably the most important part of it, I would say. Now, as Catherine said, it can play through in a number of ways, and they're not mutually exclusive, let's be clear. So we could have higher inflation, clearly. We could have lower wage increases than would have been the case otherwise. We can have some loss of employment, so some degree of reduction in employment to reduce the cost of employment. We could have, obviously, a squeeze on profit margins, and we could have an increase in productivity. That tends to be rather slower. But look, all of those things could happen. So we, so far, have really not made any strong conclusion on that. We really want to see the evidence. So in the forecast we made, we made some pretty, sort of, as did the OBR, actually, we made some pretty neutral assumptions about that, really. So we need to see how that plays through.
Okay, so we're getting a sense of why it's going to be gradual, I think. Yes, very clearly. Lona Mavo?
Thank you, Chair. Good morning, everyone. I just had a little question, I just wanted to probe on this, on your agents and this pay survey, specifically. Before I move on to my next question, with your pay survey, how comprehensive is it of low-paid sectors that are quite hard to reach that will be impacted positively by the actions taken on the budget around investment on construction and infrastructure investment and the rail settlements? I'm just wondering, I know in a previous role I've worked with quite a lot of low-pay data, and it's sometimes very, very difficult to get to some of the supply chain sectors and some of the harder-to-reach ones. I just wanted to know a bit more about what your process is around that.
No, that's a good question. So I'll start, I'm sure colleagues will come in. First of all, we do construct the agents' contact sample, if you like, quite carefully to make sure that it's got a properly weighted sample of the economy in it, because that's important. I mean, we don't want to have a, you know, biased sample. And obviously, that, I mean, you put all 12 of them together, it's quite a big sample as well. I can also tell you from, I spent a lot of time with the agents, that in sessions I do with their contacts, the National Living Wage is a very prominent subject of discussion. So I can tell you that it is clearly on the minds of the companies that they see and we see. So it comes through very clearly. If anything, actually, I would say our staff, when they do the overall macro assessment, say that, you know, the pass-through of the National Living Wage is possibly a bit less than the level of comment we get would suggest, and we have to weigh those things. And we spent a lot of time in the MPC actually with that weighting issue as to how we think about those two things. So, and by the way, I mean, you know, the agents, just to give you an example, the agent sample includes, you know, a full weighting of services firms, and services firms tend to, parts of the services sector have more low-paid workers in them than some other parts of the economy. So, you know, I think we're pretty reassured that the agent contact sample picks that up.
And I also note that you mentioned the agents, but there is the Decision Maker Panel, which is a different set of firms surveyed through a different sort of formal survey, monthly basis. And so we're getting these steers from two independent sources, but at the firm level. So I think that's a very important way of getting information.
A little dissonance, right? For samples that are designed explicitly to be representative of the economy, then the macroeconomic is, in some sense, the aggregation of all of that. Although again, there is independent data, you know, that comes from on prices and wages and so forth.
Yeah, just, I mean, I was going to make the point which is the agent survey is one of many, many sources of data we try and use. In space, we've got the Decision Maker Panel, as Catherine says. Of course, we also use HMRC, DWP data, and so far as we have it, the Labour Force Survey. We may or may not come on to, but that's another source. We also have a lot of information through sort of credit data and the like that also looks at people on lower income. So it's, you know, we're putting all this together. As you've heard, actually, at the moment we're hearing quite, well, slightly different things around some aspects of the labour market. In particular, the Decision Maker Panel has wage expectations at a slightly higher level than what we're sensing from our agents. But that's why we're looking as far as we can at all the sources of data in the economy, trying to cross-check them, trying to work out what can they tell us, what can they not, where the uncertainty is. But we do put a lot of effort into trying to understand, as you say, the sort of lower pay end of the labour market as well.
Yeah, and you're confident the lower pay representation from the agents is not focused solely on hospitality and retail sectors?
No, comprehensive. So I suppose that's what I was getting at. It's comprehensive. There will be a lot of them in it because they are big employers across the country, but we do everything we can to think very sort of intentionally about how we put that sample together and keep that under review.
Lovely. So, moving on to mortgages. So obviously we saw last week that when the interest rates come down, the mortgage rate has actually gone up. A lot of the big lenders on the two-year fixed-term mortgages, that's going to have a huge consequence on my constituents in Darlington, all of our constituents across the country, who are, you know, hard-working and trying to get by in a difficult climate. What thought was given to that? Is that what you expected to happen, and what's your sort of feeling about why that's happened?
Well, mortgage rates have come down since August. So if we look at the period since the August Monetary Policy Report to now, mortgage rates have come down. There has been pass-through of the cut that we made in August. It's too soon, by the way, to really talk about the cut we made last week. That takes time to come through. But just to put that into perspective, the majority of mortgages in this country, by quite a large majority now, are fixed-rate mortgages. They're not variable-rate mortgages. So they are priced off the swap curve in the market according to the duration of the mortgage. So they're sort of usually sort of four, five years, seven years. So mortgage pricing, therefore, reflects the swap curve and how that responds. So of course, that will be influenced by what we do, but whereas variable-rate mortgages were much more directly affected by decisions we take on the bank rate, they're now intermediated more through swap curves. So the curve did rise. I mean, the curve rose, I would say, really for sort of, we've had quite a lot of event risk recently. I mean, there were two things that moved the curve around. One, there was a reaction to the UK budget. Secondly, there's been quite a reaction to the US presidential election. So we have seen some rise in the curve. It hasn't, by the way, reversed all that we've seen since August, but you will see some increase. Your point about mortgage pricing reflects the fact that the swap curve has risen somewhat, and so banks price off that curve.
So you think the US has had more impact than other...?
Well, I think they both had an impact, actually. And by the way, I mean, you had a, I mean, obviously they're slightly different timing, so you had an immediate impact in the UK, but I would say, if you take that week, I would say by the Friday of that week, it was the US, it was the expectations of the US election, and then of course the US election itself, that has more driven rates. It's not unusual for our rates to be moved around by the US curve, by the way. That's not at all unusual. We've seen that quite a bit this year, for instance. So I think more recently, the strengthening of the US curve has been the thing that's done it. Though this morning they're both off, actually, so we'll see where that goes.
Just to pick up on that one point, and then I'll let somebody else talk. So you said it's too soon to talk about the current reduction in the rate. When would you anticipate mortgage rates to be coming to be more reflective of that?
Oh no, I was talking about general pass-through, including deposit rates, for instance. So mortgage rates, of course, will move rather faster because the curve moves rather faster, and so banks do tend to, or lenders do tend to reprice their mortgages rather faster. But to get the whole pass-through story, including deposit rates, you have to wait for a bit to see that.
Thank you. Just earlier when Professor Taylor talked about inflation, he said his views were skewed to the downside. I wonder if each of you could tell me whether you see it downside or upside. So perhaps start with Dr. Mann.
Well, in my comment on my decision to hold in November, I outlined a variety of different reasons, both associated with pricing behaviour of firms or strategic pricing by firms, strategic wage setting within negotiations, the potential risks associated with National Insurance and National Living Wage. All of these are upside risks to my view. The only downside risk that I can think of in the current context is global pricing of goods coming out of Asia. And other than that, I can only see upside risks. And in addition, I think it's important to note or to take into account that when inflation has an upside bias to it, that firms and workers both react to that by pricing by upward bias. There's downward rigidity, there's upward ratchet, and that is an important consideration in my decision-making.
Yeah, so actually, I would distinguish between the risks and the consequences of those risks. So I see the risks actually to inflation as broadly balanced. I do take seriously and share some of the concerns Catherine has about the upside risk that inflation might be higher because of some of the structural changes we might have seen in the economy. I do, however, also see that there are some downside risks to inflation. We might see a slightly softer outlook for the UK economy. So I see actually the inflation outlook as broadly balanced. I think I'm more concerned about the upside risk, the structural change, because I think the consequences of it in terms of the sort of cost to the economy would be high if we were to see inflation being slightly entrenched at a higher rate. So I would separate out the probability of something happening and the consequence of it happening.
Professor Taylor, did you want to add anything?
I'll come to the... yeah, I mean, I do want to add something there. I think the Bank Independent Review was excellent in getting us to kind of get away from the central forecast and think about scenarios and risks around that forecast. We may talk about that some more, so I think we're going in a good direction. I want to emphasise that my probability on case three is not zero. It's gone down, but it's not zero. And so I share some of Catherine's concerns. I just think the evolution of the data has pushed me to a different position than six or 12 months ago. In terms of what are the headwinds, I think the point about mortgages was a good one. I mean, the curve has moved around for lots of reasons, as the Governor said. If you take, you know, a bond trader and you put them to sleep three months ago and woke them up today, and you said, you know, what's going on with UK gilts, you know, the yields have gone up, but the first thing they would ask you is, well, what's happened to US ten-year? Well, they've gone up, they've marched up together, which reflects global sentiment. There's been risk-on for equities and bonds have gone up for mainly global factors. So in the short run, you know, that's going to weigh on mortgage pricing for reasons that are external to the UK. And there could be other global risks ahead which we may talk about. But even before that event, you had, because of the staggering of mortgage pricing, and I think there was an FSR report chart about this, that because of the resets coming, we were going to see debt service ratios rising over time. So that's like another force that's weighing on the consumer. I mean, the other things that were shifting my view, vacancies have been coming down, that's been normalising. But also, because of problems in the data and the uncertainty around the outlook, I put a lot of weight on what the agents are saying. I made my first agency visit to Scotland in October. I intend to do a lot of those despite being based in New York. I'm going to Leeds in January and to Bristol in February. And what I heard there, and it's consistent with other agency feedback we're getting, is the kind of wait-and-see attitude that's prevalent. You see that in firms, and I think they've been saying that for a long time, well, we're going to invest, and well, you know, I think rates are going to come down, and I think the economy is going to improve. And then the agents will go back, you know, weeks, months later, and they'll get the same response. It's like kind of rolling forward. There's a similar phenomenon, I think, in the way households are behaving with respect to saving. It's maybe precautionary or other motives, and historically that's sort of symptomatic of what happens after big crisis events. The Great Depression, you know, listening to my parents kind of telling me about how their thinking evolved, or you think about COVID or a pandemic, a global financial crisis, people take on maybe a slightly different view of spending and savings. All of that is, to me, weighing on the economy. And NICs, for the reasons that the Governor mentioned, are going to possibly dislocate the labour market. So there's a lot of factors just making me very, very worried now, wanting to focus on that labour market view in the weeks ahead.
And we're going to come on to whether the budget has maybe begun to move the dial in a moment. But Governor, which way do you...?
I'm pretty, very close to where Clare is, actually. I've got risks on both sides. To be honest, if you'd asked me this question a month or so ago, I'd have probably been a bit closer to where Alan is. I think the structural argument, as Clare says, has to be given weight, and I do put weight on that argument because actually it's harder to counteract the structural argument. We'd have to lean harder and for longer. But I just go back to the points I made about the impact on employment costs of the budget, the way I set those channels in which it can transmit out. Of course, this could be either upside or downside for inflation. So you could get higher inflation, but you could get quite a weakening of the labour market and outside pressure on pay.
Okay, great, thank you very much. Harriet Baldwin?
Thank you very much, Chair. Starting with Ms. Lombardelli, because we've heard about the Bank Independent Review. It was done after central banks around the world and the Bank of England had a poor forecasting record through the last inflation crisis. And I know you're in charge of implementing the 12 recommendations that he set out. I think I could detect some subtle signs in the latest Monetary Policy Report of some change, but could you summarise where we've got to in terms of the implementation, of course?
And thank you, Harriet, for asking me and giving me the opportunity to talk about it. So we've started the process of implementing the response to the Bank Independent Review. This will be a pretty big programme of work. I mean, as you know, his review was comprehensive, it was wide-ranging. We are, as a result, looking at pretty much every aspect of the way in which we do monetary policy. So that's our processes around the sort of the way we structure the committee's time and what we use that for, the technology that we have. He brought out a lot of the issues around the technology that the bank currently uses, including our models.
Yes, but not just actually. He recommended that we have a sort of wider range of models, and in particular models that can help us with structural and supply-side shocks to the economy. The way we think about data, and we think about that in the context of our policymaking, what I call policy strategy, which is how we think about these questions of how should you set policy under uncertainty. Some of the things I talked about before about not just being the probability of outcomes but the consequences, and if you're in one world and you set policy, if you're in another, what could that mean? And how we communicate. So there's a whole range of things there, and they're all sort of interrelated. One of his big recommendations was actually focus less, as Professor Taylor said, on the central forecast and use it less as a communication device. Of course, if you do that, it raises a lot of questions about, okay, so what do you put in its place? How do you think about that communication? How do you do that in a way that is clear? So in a sense, we have all of these things sort of interrelated with each other. We, as you say, there was a sort of hint of it, we did begin some tentative sort of steps in this direction in this round. We changed the way which the committee used its time. We spent more time talking about how the economy might evolve, what the implication of that would be for policy. You can see the result of that in the cases that we set out in the box. We did that, so the cases are the scenarios that he described.
Yeah, that was us thinking about different ways in which the economy might evolve. If you take, you know, all of them in a sense are consistent with the data as we see it now, but the question is going forward, actually, what's going to happen next? And that was, that is sort of sharing how we thought about different ways in which from here we might see the economy. There's uncertainty around that. We spent more time in this round talking about those possibilities, how the data stacks up against them. So what does that mean for, you know, how do we assess the likelihood of them? How do we think about what policy would mean in those spaces? And so we've set out a box that sort of talks about that in a bit more detail. I would say that's a small start. There's a lot more to come on Bank Independent Review. This is going to be a big reform programme. It's going to take, you know, a long time.
How long is a long time?
Gosh, at this point, I don't... I mean, it's going to be years, not months, I would say, to reform. We'll be able to see sort of small incremental differences every time.
Would you say... I don't anticipate we're going to sort of go away, you know, sit in a bunker and then after three years go like, 'Ta-da, here's our new policy.' I think we will be gradually sort of testing approaches. We're going to have to learn as we go because this is quite different. So you will, and I'm sure we'll talk about it again, but it's a big programme of work, but we're starting that now.
Thank you. And Governor, in terms of the central scenario, it shows that inflation rising to 2.8% next year and about over 40% chance of us having inflation go back up to 3% next year. If you were required to write a letter to the Chancellor about the 3%, don't you feel that that would be a bit of a failure, that the British public would feel pretty let down that inflation was back up to 3% again?
Well, but I also have to balance that with the fact that the forecast brings inflation back down to its target sustainably at the sort of, you know, at the horizon. So, and of course, that's what we look at. So then we have to ask the question, you know, how much tightening should we do, or how much more restrictive should we be with that profile of inflation in mind, given that there is a cost to being restrictive. And this is the whole element of what we call the trade-off, that is language that is in our remit, and that's a judgment we have to make. And it's obviously a much smaller judgment than some of the judgments we would have had to make in the past given where we've been. I obviously would much prefer that inflation doesn't go up to that level, but I think that it is, you know, this gradual approach towards taking restriction out will allow us to adjust as we go along to the evidence we see. Just to make the point again, the evidence we've seen recently has been that the outturns have been lower than we thought they would be, but we don't know whether that's going to continue. But we'll see. I mean, we're judging... that's part of the relevant picture to judging our response to that forecast, because let me make a point that's been made many times before: there is not a mechanical relationship between the forecast and the policy decision. That's important. The forecast informs the policy decision. As Clare said, the way we're developing it, the use of the cases informs it even more, but it isn't a mechanical judgment. We have to make those judgments, and I think it's an appropriate judgment for this point in time.
Okay. And you mentioned in your annual report to us, and you've mentioned in your evidence today, about these four different ways in which firms can pass on the extra cost of employing people. And I just wondered if you could tell us if you fed into your model that only one of those routes was going to happen. So, for example, reducing employment was the only way in which things adjusted. Does your model tell you how many jobs that represents?
Well, we didn't do that, actually, because we didn't make an assumption that there would be one reaction only. It would, there would be, yes, we would have a sharper rise in unemployment. We've actually now, we've got a pretty flat profile for unemployment now in the central case. But I would hazard a guess, without having done it, that it would be a bit higher if you made that assumption. The Office for Budget Responsibility do have a figure for that. They say that employment is going to be 50,000 lower as a result of the measures in the budget. And you'll have seen the letter from the British Retail Consortium this morning as well. And I just wondered if you think that sounds like a plausible...
I think, well, first of all, I think the OBR one, because we talked to them about it, they made pretty similar assumptions to us about the way in which this will pass through. And by the way, if I could add, one of the points, by the way, the pass-through in terms of the allocation between these channels does not have to be constant over time, and I doubt it will be, actually. Probably initially there will be more pressure on firms' margins because it takes them longer to adjust, and then they'll probably rebuild those profit margins. That is, over time, I would expect that. So it can change over time. I think the OBR made a pretty similar set of assumptions to us. They put more on a combination of some increase in inflation, some wages being somewhat lower than they would have been, and something on profit margins. I saw the BRC's letter, and I think they're right to say I think there is a risk here that the reduction in employment could be more. Yes, I think that's a risk. And similarly, if it were to feed through exclusively through inflation, what impact would that have on the economy?
Well, that would be again a rather larger effect than we have got factored in, because we factored in some labour market effects, because we factored in wages being lower than they would otherwise have been. So I think again, you know, I think at its peak, the contribution of the budget to the inflation profile is half a percent. You know, it would be a bit more than that, obviously, if you made different assumptions on the pass-through. But I think, you know, I would caution, I don't think it's sensible to sort of load it all onto one of these channels.
I have to add in here that the fundamental driver of the decision of firms to make adjustments on any one of these margins, it depends on the demand conditions that they face. So that is intimately related to the outcome on labour market tightness or wage developments, prices, or even investment and productivity. So the underlying demand status is the primary factor to be considered when making these other assessments. And I accept that it will feed through in four different, you know, potentially more than four different ways.
But I just wondered if your models allowed you to put in if the adjustment were all through this mechanism or this mechanism, what the impact would be?
Yes, they would. We would be able to do that in principle, yes. Well, if we had Labour Force, if we had the labour market flow data, then we could make some judgments. But in the absence of that flow data, which we've discussed before...
You could share that with the committee?
We could look at something and write to you, yes. Because although Clare's right, I mean, there is uncertainty around the Labour Force Survey, we can, to some degree, sort of put that... yeah, it's a little bit abstract, but we can put that through our... we can make some assumptions about it, certainly. I would just, on the point Catherine made, the only caveat I would add there is that one of the things that firms said to us quite a lot, or have said to us quite a lot over the last few years, is that there has been some what I call labour hoarding. I don't want to be pejorative about this, this was a perfectly sensible reaction, particularly during COVID. If that still is the case, then it might be rather easier for them to shed cost than it would be if there wasn't, by letting people go.
Okay, thank you. John Glen?
Thank you. Governor, could I ask you about the Trump policy on tariffs and what assessment you have made about how that will affect the UK economy? Credible sources say it will see a reduction of GDP by 8%. It will inflate the value, the cost of exports into the US, and we'd see a reduction of 22 billion. Obviously, there's a whole world of politicians responding to that, and it's speculation over where that would affect. But if that was the case, if that was the imposition of the 20% tariff, how would that affect your thinking about the impact on the UK economy?
Well, first, I should say, first of all, that although we were able, as colleagues have said, to feed the, to incorporate the impact of the UK budget into what we did, we were not able to incorporate the impact of the US election result because it literally came on the day we were taking the decision. So you can be forgiven for that, quite transparent that that is not in there. I also want to be very clear that I think it's very important that, you know, we wait to see what the administration actually does. You know, to borrow a phrase from one of my colleagues, you know, we wait to see when all is said and done, and we've seen the said bit, but we haven't seen the done bit. And I think, you know, US elections don't quite have the same tightness of tie to what I would call the manifesto as I think British elections tend to do. So let's wait and see what they actually do, because I think that's really important. That's what we'll be doing now.
I think that will take to feed through them quite a while because obviously they were coming. It wouldn't be really till next summer. You're thinking that we'll... well it depends. I mean obviously it depends on what speed they take decisions. So let's... I obviously don't actually take office until late January, so let's see what happens. To your point though, Mr. Glen, we would need to know quite a lot of other things and obviously take views on quite a lot of other things. And those other things are not just the tariffs that were implemented by the US, what the tariffs were implemented on, what the reaction of other countries is to those tariffs, how that fed through to exchange rates because they'll affect the relative cost of doing business. So I'm very cautious about jumping to conclusions about what the effects of tariffs are. I will be very clear that fragmenting the world economy is not a good thing, quite clearly I have to say that. But I think what the effect of particular tariffs would be, particularly if there were different tariffs against different parts of the world, also accepting that the UK has a larger share of services in its trade than other countries do, and on the whole, services are different in that sense, tariffs don't work in the same way in the services world. So we really would need to see all of that before reaching any conclusions.
I respect that, but I think people will be looking for you for wisdom on the relative choices that a government faces. We're in a situation where you referred to the implications of Brexit in your speech last Thursday evening, and the government have stated their objective to reset that relationship. And there will be tradeoffs in that in terms of the impact. If you remove some of those frictions, what would that mean in terms of greater freedoms of movement with young people potentially, for example? How do you... and we also look to China around the uncertainty. Obviously the Prime Minister met with the President yesterday. In terms of the uncertainty around how they will stimulate the economy, yes, for us trying to scrutinize your analysis, how do we determine what your judgment is about the best course of action for the government? Because it seems to me there are tradeoffs between a situation where we're subject to the negative impact of those tariffs, and there are consequences of a reset of the relationship. Now you will of course say these run certain pathways, but what would you say about what is most desirable for the UK economy?
Well, first of all, let me say, split it into two parts. First part, we will be very transparent about the analysis that we do and the judgments we reach, and we'll be happy to share that analysis with you when we get to a point when we can do it. No question about that whatsoever. Just on the point you referred to, points I made last week, let me make two comments on that. First of all, I described myself last week as a sort of dyed-in-the-wool free trader, and I am. I don't think free trade is about choosing one area over another. I mean, this is not in the history of this country. We should approach all areas of the world as places we trade with. We should therefore be in an active dialogue with the Trump Administration on those policies as they affect the UK. Likewise, we should be in an active dialogue with the EU as well. And I'll just say one thing on that if you don't mind. As you know from your previous... you spent a lot of time on this. We have spent the last eight years implementing Brexit in the financial services world, and I would like to say I think that the outcomes have been so far... it's never over by the way, but the outcomes have been better than we feared they would be back in 2016-17. Now one reason for that is that, and I said this to my colleagues right back in 2016 at the start, we have to maintain an open dialogue and open relations with the European Union because they have to trust us with financial services. And I think we've done that. We put a lot of effort into that. And I find it hard to understand people who seem to say that we should implement Brexit in the most hostile fashion possible. And I take no position on Brexit, I never have, but I've always said it's my job to get on and do it, and I'll do it in the best way possible. And I think having a relationship with the European Union is the better way to do it in that sense.
Can I just push you just for one final... I agree with what you've said, and obviously we've spoken a lot when I was a minister together, a lot very constructively on it. But obviously there's an impression out there that the government will have to make a choice between those, because we know that the instincts of the new president are perhaps to see things in more of a binary fashion about the direction that the UK government wishes to go in. And I think what we're trying to draw out is where does that hard moment actually come to crystallize for the UK economy? Because there may be choices that mean that you can carry on that dialogue both across the Atlantic and to Brussels, but you have to make choices. And I think what we're asking you as a committee is, you know, when does that moment crystallize?
I think it only crystallizes once we have a much better idea than we do today of what the Trump Administration will intend to do. I don't think we can make that judgment today because we literally do not know what their intentions are. We've heard things that were said during the election campaign, but until we have a very clear sense of what they are, I don't... but I said look, we'll be happy to come back and give you our assessment for our responsibilities. I'm not... obviously the government has many other responsibilities. Once we know that... thank you very much, Mr. Glen.
I might add, how firms choose to respond to whatever the policies might be is a key ingredient to the outcome. And we can potentially, once there was some clarity about the policies being put into place, we can add questions to our decision maker panel as was the case during the Brexit negotiations and so forth. We can get an impression about what UK firms are doing in reaction to whatever policies are put into place. But until we get the policies, we can't ask those questions. But we can get a lot of insight from our firms who are ultimately the ones who are going to make the adjustments one way or another. I wonder if Professor Taylor, also based in New York, whether you have any perspective on this before I go to Mr. Coghan.
I don't know if on this that gives me any extra wisdom. Wisdom's clearly going to be a repeated word. I think my take on this is, as the Governor said, we need to wait and see what actually transpires. And the range of uncertainty that we face now is magnified considerably by that. I mean the lessons of economic history and economic theory I think are clear. If you're a large country, you may be able to use trade policy to your advantage. For a small country, that's very difficult. The world just goes on, and most of the costs that you... if you impose trade barriers, fall on you. That's point number one. And point number two, if you were to get to a trade war with lots of retaliation, that raises the problems to an even higher level. Just to... the Chancellor did say very clearly that she was not keen to get into a discussion about tit-for-tat tariffs and that wanted to be a free trade nation, and that was on the record to us a couple of weeks ago.
Thank you, Professor Taylor, for your comments. Just building on that, of course, trade war is in nobody's interests. But during the first Trump Administration, of course, Vietnam and Germany were actually major beneficiaries from displaced trade between the US-China trade war. Is it possible that there's a similar opportunity for the UK in the event of an EU-US trade war? And if so, how should the UK think about being positioned?
I think it's a very standard piece of trade theory, and it's something that's replicated in countless studies. That interventions in trade policy will cause trade diversion. If you're the party imposing the barriers, your trade goes down, but water finds its level and trade flows will reallocate. So if we see major changes in trade policy around the world, then it's going to redirect trade flows, yeah, for sure.
And Governor, in your comments on Brexit, and we also spoke about in your Mansion House speech, you told me what the Bank's best estimate is on the impact of Brexit on UK inflation in the short term, and also investment and productivity in the long term?
Well, we've produced assessments in the past on the impact on investment and productivity. We've said we do think it would have an initial negative effect for the reason that I said last week and I've said actually a lot of times before including to this committee I know in the past, which of course is that if you reduce the openness of an economy it has those effects. And I think the evidence we've seen so far largely supports the judgments we've taken in the past on that front. So I'd be happy to send that again if you'd like for the committee.
Thank you. And finally, for Ms. Lombardelli, many are advocating seizing the 300 billion in frozen Russian FX reserves. Has the Bank done... you can share with us any analysis on the potential impact of that on global capital markets, and also the potential risk premium to G7 debt, and so therefore what the potential economic benefit or cost could be to G7 economies?
I'm afraid I'm probably not the best person to answer on that one because it's not my responsibility. Very little of it is actually in the UK, by the way. I should say that 300 billion number... that was a product of where the Russian reserves were at the point when those events happened. So actually we have very little of that actually in the UK. But we've had a lot... I mean I've spent a bit of time in the G7 with fellow ministers and governors, it's been discussed a lot. I think the best thing to say is that it remains frozen for obvious reasons.
Thank you very much. Thank you, Chair, and good to meet you. I wanted to ask, probe more about inflation indices. You've talked a bit about your overall assessment with your decisions earlier this month, but we've seen overall inflation stabilize. But I wonder if you could talk about some of the indices that we might not be focusing enough on, so the other contributory factors to that. And then I'm going to come on to the distributional impacts of inflation.
I mean, I'm happy to. We're... I mean obviously our remit is clear that we are responsible for CPI and that's what we focus on. Of course in thinking about that we spend a huge amount of time looking at the different components of inflation. And you can see in our analysis we set out lots of detail what's happening to goods, what's happening to services, what's happening to what we consider sort of core, stripping out volatile, looking at those aspects. I would say, because in different ways these all feed through into the overall inflationary pressures and they move in different ways, and so we spend a lot of time looking at how those movements feed through into the overall impact. I would say when we're doing things like stripping out volatile elements, not because... we're very aware that those are very important to people. And obviously one of the things we saw in the inflation over the last two years was in particular it was energy prices, it was food prices that shot up, and of course that is extremely painful for people, particularly people on lowest incomes who spend a much higher proportion of their income on those sorts of goods and have fewer resources and ways to manage through that. So we do look at all of those measures but we keep a very firm view and are very clear that our remit is for overall inflation across the economy. But we do spend, like I said, a lot of time looking at different components of that, different ways it affects different groups of people.
One of the reasons for looking at these disaggregations, whether it be in different indexes or looking at different income groups, and by the way if we look at the contribution of mortgages to the middle income category, each one of these groups does have a different basket and so they have a different real behavior of their real income purchasing power and they will save or spend differently depending on that. The reason for doing that is to evaluate the dynamics of consumer behavior over time. And without looking at those dynamics, because those things have changed, so you can't just look at the macroeconomic data. So it becomes a very important ingredient in informing our decisions. It also has implications because of the way in which various policies, for example the energy price guarantee, filtered through different groups in different ways.
So taking those points and building on it, I understand that you're focusing on CPI but you do take into account other indices and you've acknowledged already the experience of high food costs. How do you think that experience of high food costs will be affecting demand to the point that Professor Taylor was making a bit earlier?
Yeah, what we do, and actually building on what Catherine said, what we do is we look at when we're thinking about demand, we think about actually if you look across the economy, different groups of people in the economy and what is their propensity to save and their propensity to consume. It is obviously the case that people on lower incomes consume a higher proportion of their income, but of course their income is lower so they constitute less of, if you like, the demand in the economy. That disaggregation is one of the many ways in which we think about demand in the economy. So for example when Catherine was talking earlier about the impact of the budget, one of the things that a point that she's highlighted is a lot of the spending at the front end because it's actually through public services that will be distributed across the economy geographically more so than other forms of spending might be. And so you see how that plays through into demand geographically. So that will be one of the sorts of examples in which we think about the way in which different groups of people, whether that's by income, sector, geography, will be consuming, will be saving, and therefore how that all adds into demand.
Our staff did quite a lot of work, as do staff in other central banks, on what shapes people's perceptions of inflation. Now there's a difference between perceptions and expectations. Expectations are what people think inflation is going to be in the future. Perception is what do you think it is today. And the reason I say this is because the results tend to suggest that people's perceptions are shaped more by the things they buy more frequently. I mean, it's not a great surprise really, but of course food and energy have therefore quite a high weight in those perceptions.
Just to follow on from that, and your analysis of demand, and we have analysis of the impact of inflation and interest rates on mortgage holders most recently. And when you're looking at that income distribution and how people are affected by inflation, how are you balancing an understanding of mortgage holders with perhaps people who aren't mortgage holders and their perception of inflation?
Look, I mean we have lots of sort of data on actually who holds mortgages, and of course it is a subset of the British population. Some people, you know, homeowners without a mortgage, some people have mortgages, some people are renters or indeed don't... are in a different set. So we do think about... I mean the other thing to bear in mind with mortgages, and we touched on this a bit earlier, is actually because so many are fixed rates, you've got a real distribution out there about the rates people are paying. I mean you do still have some people who are on very low rates reflecting fixing a while ago, you have some people on much higher because they've changed. But we will think about that in thinking about actually what is their disposable income. So we do think about their income after their mortgage cost and therefore what is their ability to spend. So again it's another way in which we cut the data to understand actually what our households, you know, what is the position they're in now, but also thinking about how is that likely to evolve, because that is critical to us understanding how demand is likely to evolve. I mean consumption is by far and away the biggest portion of demand, and that is as Catherine says absolutely critical to what will we therefore see in pricing behavior, because firms will be thinking about actually how much demand is out there when they're setting their prices, and that obviously feeds directly into inflation. So these are all ways in which we are trying to understand the current situation in terms of what is happening and how that will evolve going forward.
And final question, how concerned are you about volatility in that demand given perceptions of inflation?
I mean, it's sort of... I mean again one of the things that we look at, I mean you do look, the overall GDP data is, you know, it moves around. We had quite a bit of weakness at the back end of last year, there was sort of strength coming into this year, it's sort of that strength sort of easing off now. We said we sort of try to look through in a sense the volatility in terms of thinking about what will inflation be in the future and therefore how do we set interest rates now. But of course we are monitoring all this data to try and pick up are there trends, you know, how much of it is volatility in the sense of its noise, how much is it giving you a signal about what's going to happen in the future. And so we do look across the piece including as I mentioned earlier at some of the things we... some of the data we have in the sort of credit space as well about actually how much demand is there and what are we seeing in terms of households and their sort of position.
Okay, I mean it's interesting you mention credit because I think we talked a bit about mortgage holders, you mentioned renters. There are a lot of people... so my constituency could be broadly divided into people who can afford to work four days a week and those who work four jobs over seven days. So do you... I mean Professor you talked about going visiting agents and credit unions for talking to people on the ground. Do you... but do you gather any data about those people having to work multiple jobs on low wages? Because that will have an impact on their disposable income, confidence is different in that bracket. Obviously perhaps maybe the danger is we tend to look at the top tier and perhaps not understand the...
One of the things that we also do as well, well actually do often as part of the agency visits, is that we do two other things. We do what we call community forums where we meet people who are not typically running businesses but are more in the type you've described. We also meet then in a separate program people largely from the charitable sector who are dealing with the issues. So I was in Surrey last month and did a session with people in Surrey who run... who are doing the charities that are supporting those sorts of people. So that we find very helpful in terms of giving us the feedback that we won't, as you rightly say, get from the normal agency contacts.
How do you use that feedback?
It all goes into the pot, as it were. I mean, very deliberately.
