Oral evidence: Bank of England Monetary Policy Reports, HC 143
Wednesday 6 September 2023
Ordered by the House of Commons to be published on 6 September 2023.
Members present: Harriett Baldwin (Chair); Mr John Baron; Sir James Duddridge; Dame Angela Eagle; Danny Kruger; Dame Andrea Leadsom; Siobhain McDonagh; Anne Marie Morris.
I: Andrew Bailey, Governor, Bank of England; Sir Jon Cunliffe, Deputy Governor for Financial Stability, Bank of England; Dr Swati Dhingra, External Member, Monetary Policy Committee; and Elisabeth Stheeman, External Member, Financial Policy Committee.
Witnesses: Andrew Bailey, Sir Jon Cunliffe, Dr Dhingra and Elisabeth Stheeman.
Chair: Welcome to the Treasury Committee’s evidence session on the Bank of England’s recent Monetary Policy Report and Financial Stability Report. May I ask the witnesses to introduce themselves, starting with yourself, Governor?
Andrew Bailey: I am Andrew Bailey, Governor of the Bank of England.
Elisabeth Stheeman: I am Elisabeth Stheeman, external member of the Financial Policy Committee.
Sir Jon Cunliffe: I am Jon Cunliffe, deputy governor for financial stability.
Dr Dhingra: I am Swati Dhingra, external member of the Monetary Policy Committee.
Q868 Chair: Thank you very much. I will start, if I may, with the Governor. Clearly, inflation, which is such a terrible tax on our economy and particularly harms those on the lowest incomes, is still far too high for any of us to feel comfortable. I know that over the summer you announced that you had asked Ben Bernanke, the former Federal Reserve head, to lead an investigation into your modelling and, as I understand it, related processes. Can you tell us when you are going to publish the terms of reference, Governor?
Andrew Bailey: Yes, I can; thanks, Chair. I should say, of course, that it is the court of the Bank that did this.
Chair: It is the court of the Bank—yes, I should have said that.
Andrew Bailey: I think I can speak on the court’s behalf. Ben Bernanke is already engaged in the work. We wanted him to be engaged before we finalised the terms of reference to get his input to the terms of reference, which is very valuable. The court is meeting on 22 September. I expect that they will finalise the terms of reference at that meeting and publish them shortly afterwards.
Q869 Chair: In terms of the modelling, one of the factors that we were surprised to learn about when we last heard from you and the chief economist, Huw Pill, was that the modelling had something of a recency bias built into it, looking at the years since you have been independent, and that the ’70s, when we last had a big energy crisis, were not necessarily something that would be captured by the models.
Huw Pill sent me a long letter in June. There was one paragraph where I was not entirely clear whether he meant that this had been implemented or whether it was something that had happened some time ago. It was around incorporating the information from the ’70s and ’80s. On page 6, paragraph two, of his letter, he says that “Bank staff have adopted” an approach where they look at the academic literature and some of the “surge in inflation” that happened in the ’70s. Could you update us on when that started to happen at the Bank?
Andrew Bailey: To put this into context, there is not a single model. We have what we tend to call a suite of models, and that is deliberate, because to rely on one model would be a mistake. As Huw said, the reason why we tend not to use data from the ’70s is that, among other things, the macroeconomic policy regime was very different then, so the reaction functions of policy were very different.
However, on the point that Huw was making, there isn’t a single date for this, but in the work we do and the work that staff do for us—they obviously do a lot of work, and they estimate new models regularly in doing that work—they can, of course, go back and look at the ’70s and often, I am sure, will. Sometimes they will estimate things—
Q870 Chair: Can you clarify whether the Monetary Policy Committee, in your deliberations since the invasion of Ukraine, spent time talking about what previous energy shocks had done to inflation?
Andrew Bailey: Yes, we have certainly looked at previous energy shocks.
Q871 Chair: You discussed them at the Monetary Policy Committee.
Andrew Bailey: Let me give you one example from my own thinking on the subject. We have talked once or twice in the committee about the distributional effects—what I call the labour share and the profit share. It is useful to go back and look at the ’70s in that respect and to contrast and compare what we are seeing today, in terms of the moves of those shares, with what happened in the ’70s. Actually, what happened was quite different, but even though it is different, it is interesting and informative to do that, even though we make it clear that that was a different story.
Q872 Chair: I noticed in the Monetary Policy Report that you have some new analysis. It states that “there are non-linearities in the way inflation is reacting to changes in demand” and that “the response is greater…when spare capacity is more limited to begin with.” That seems like a fairly obvious insight and one that we learned from the ’70s and ’80s. Was it one that you think had perhaps been forgotten by the Monetary Policy Committee?
Andrew Bailey: I think it is interesting. Let me add the caution—just to go back to my other points—that when we look at the responses of inflation now and then, there is the important difference that the responses now are within a framework and a regime of inflation targeting, whereas they were not in the 1970s. That, of course, is an important difference in terms of judging, comparing and contrasting the responses. I think it is interesting to look at, but I would always draw this cautionary note: that without what I might call the anchor of the regime, you will get different outcomes and different processes.
Q873 Chair: We did our own sort of external review. We invited in some experts; I am sure you have read the transcript from 5 July.
Andrew Bailey: I have.
Chair: We asked them about these sorts of issues. One of the things that they highlighted in addition to the modelling issues, where, as you say, the court has established a review, was some of the concern around the recency bias and the fact that there seems to have been a de-anchoring. Anchoring will only work if the public trust you to manage to achieve 2% over time.
It does seem—certainly in terms of the strike action, the wage demands that we are seeing across the economy and the high level of private sector wage increases—that, basically, the public have given up on hoping that the Bank will get inflation back down to what is targeted any time soon and they have demanded those pay rises, which is causing second-order effects in terms of inflationary pressures.
Andrew Bailey: If you don’t mind, I will tell a somewhat different story around that. As we have said quite a lot of times before, there has been a very big terms of trade shock in this country, which has affected national real income. That inevitably gives rise to a distributional question. It is not, of course, for us in the MPC to determine the outcome of that, but it inevitably gives rise to that question, and I think that is what we are seeing in the wage bargaining.
The issue now—and this is a very important question for where we are in policy setting—is that you are right that, when I look at it today, many of the indicators are now moving as we would expect them to move and signalling that the fall in inflation will continue. As I have said a number of times, I think it will be further quite marked by the end of this year. However, wage bargaining is one thing that has surprised us the other way in recent months. The question now is that as headline inflation comes down—and I hope people become more confident that it will continue to come down, because it has now come down quite noticeably, but there is a long way further to go—
Q874 Chair: So you do not accept that expectations are de-anchored.
Andrew Bailey: What I am saying is: will we see inflation expectations continue to come down, because we have seen them coming down, and will that be reflected into wage bargaining? If I look at the DMP survey—the decision-makers’ survey that we do—we ask firms in that survey, “What is your expectation of wage settlements for the next year?”, and it has started to come down. I think the latest figure is 5%. It was 6-something—
Andrew Bailey: Yes, but my point is that that is as—
Q876 Chair: If that is not a de-anchoring, I do not know what is.
Andrew Bailey: Hang on—that is my point. This is as expectations of inflation coming down become more embedded. Will we see that continue to come down? It is on a downward path now. The question is whether we will see it continue to come down. That is important for our policy decisions now, because that is what shapes a lot of our thinking about the direction of policy now.
Q877 Chair: We have talked about the modelling and the steps you are taking to look at the range of models you have. We have talked about some of the recency bias and the fact that you are wedded to this period over the last 30 years, but that you are bringing in some of the information from other periods to inform your thinking perhaps more recently. I am not sure that I am completely clear when the committee started talking about it—
Andrew Bailey: There is not a single point in time, because the staff do a very large amount of work for us for every round of the MPC. They will use different periods of time to analyse things as they think is appropriate, because the answer will be different for different questions.
Q878 Chair: So you can confirm that in every meeting of the Monetary Policy Committee since the invasion of Ukraine, you have explicitly discussed previous energy price jumps.
Andrew Bailey: No, we haven’t explicitly discussed that far back in history at every meeting. I said that where it is useful, we will do that, and we do do that.
Q879 Chair: And which meetings have you discussed that at?
Andrew Bailey: I will have to write to you and give you a list of meetings, because I do not have all the staff analysis with me, but where it is appropriate, we will do that.
I just come back to this point: there was a very big change in inflation regime in this country really in the first half of the 1990s. That regime has had a very big impact not only on how policy works, but on the economy. I do not see this so-called bias that we have as a bias. I think we are saying that there is a period in which we can see that the behaviour of the economy and of policy is done on consistent terms. We get a lot more value out of looking at that period for what we do today.
Q880 Chair: One of the implicit assumptions in the tautological situation you describe is that inflation expectations must be anchored, but that the public have to trust you to get inflation back to your target. I think the jury is still a bit out on that, but I want to talk about another example of where decision making in organisations can sometimes struggle.
We had evidence in our 5 July session about what I would call, collectively, “group-think”: group-think internationally and group-think domestically. Stephen King cited the fact that you do not really have a lot of monetarist expertise on the Monetary Policy Committee. Sushil Wadhwani cited in evidence the fact that the Decision Maker Panel, which you have just referred to, was sending out warning signs.
I also thought it was interesting to read Ben Bernanke’s book on the time when he was working with Alan Greenspan when Greenspan was leading the US Fed. He looked at such a wide range of outside indicators, including, famously, the tall buildings index and, I think, the men’s underwear index. There was a lot of qualitative information that was brought into Fed decision making at the time. Professor Charlie Bean highlighted the fact that in his experience the Monetary Policy Committee had space to discuss where we might be wrong and what the “nightmare” scenarios might be. I just wondered, under your chairmanship of the committee, Governor, whether you feel you have given enough space to look at those different scenarios, which might counteract some of the group-think.
Andrew Bailey: I am not in any sense dogmatic about how we approach the question of analysing inflation—can I just be very clear on that? On the question of group-think, if you look at the voting pattern of the MPC, I do not think you would really conclude that there was group-think in the MPC at the moment. Yes, using a broad range of data is important. As you know, we often refer to the agents that we have in the country. They get us a lot of data. The Decision Maker Panel, which I referred to earlier, was created by the Bank a few years ago to create a new sort of survey. We are, frankly, great consumers of evidence and information from all sources.
Q881 Chair: And a monetarist point of view?
Andrew Bailey: If you look at the August Monetary Policy Report—I think on around page 43 or 44—we have the money growth chart in there. Ben Broadbent made a speech on the role of money back in the summer, I think.
Chair: The summer of ’23?
Andrew Bailey: This summer. I am happy to send it to you, if you would like. If you look at the underpinnings of monetary policy, yes, of course, money is important; of course it is a monetary phenomenon. I would say that, as a short-run predictor, money is not as good in that sense. I think, if my memory serves me right, that Sushil Wadhwani made the point—and he is right on this, and it is a point that Ben Broadbent made in his speech—that you can look at it in two ways: you can look at the flow and you can look at the stock, and they will give you different reads. They will at the moment, actually. The flow read is very weak at the moment. It is actually zero; M4 growth is zero at the moment. But there is an argument, and I think Sushil was alluding to this—I do not think he said it explicitly—that the stock is larger.
Q882 Chair: It sounds as though you have been looking at this more recently rather than perhaps during the pandemic itself.
Andrew Bailey: I wouldn’t say that. As I said in testimony to the other House a little while ago, one of the things that I thought was striking during the pandemic period was that there are two M4 series—there is M4 and M4 lending—and usually there is a fairly good congruence between the two, but during the pandemic period, they were going in opposite directions. We had to interpret what conclusion to draw from that.
Q883 Chair: We have talked about modelling problems, recency bias and group-think. Another criticism that came up in that session was around the Bank of England’s communication, which was compared in the testimony that we received with the Fed’s very clear communication. The Fed was very clear that it would do what it took to conquer inflation, whereas the description that we had of the Bank of England’s communication style, particularly at the beginning of the inflation period, was that it was much more relaxed. I wondered whether you had any thoughts about any changes or improvements you might make to your communication.
Andrew Bailey: I think we have always been very clear that we will do what is necessary to return to the inflation target. I do not think we have done anything other than that, really.
There are some differences in communication styles across the central banks, depending upon the actual procedure that the central bank uses to reach its decisions. The European Central Bank, for instance, does not publish votes, whereas we and the Fed do. That makes some difference to the communication procedures. I think that when we are communicating before meetings, it is important that we sort of preserve the space to deliberate in the committee itself. Other central banks are a bit different in that respect. I think it is important that, this afternoon, none of us is going to tell you how we are going to vote in two weeks’ time; we don’t know yet, because we have not had that process of deliberation. Not all central banks follow that pattern.
Chair: That is enough from me for the time being. I am going to bring in Danny. Do you have something on this, James?
Q884 Sir James Duddridge: I have a question about groupthink, Governor. I do not have the full voting records in front of me, but for the last year, you and the deputy have voted in entirely the same way. Is that entirely coincidental or is there a particular close lock?
Andrew Bailey: We each make our own decisions. I was talking about the overall voting pattern of the committee. We have the records, so if you’d like me to—
Chair: We have them as well; thank you. Thank you, James.
Q885 Danny Kruger: I am going to come on to MPC policy in a moment, but I have a personnel question for you first, Governor. My constituents are very concerned about the cost of living and inflation. They were pretty unimpressed, as I was, to see one of your employees dressing himself up as a zombie and taking part in a protest stunt against Government policy not long ago. Do you think that is acceptable behaviour for a Bank of England employee?
Andrew Bailey: I have written to you on the subject. I would be happy to go over any points in the letter. In the letter, I set out the Bank’s policy and the fact that we are reviewing it, because I agree with you on that point: it has to be reviewed. One question is: on whose time did that occur? That is a relevant question. But I hope I set out the Bank’s policies clearly in that respect and they have to be abided by staff at all times.
Q886 Danny Kruger: Yes. I am grateful for your letter, and I am pleased to hear that you are reviewing your policy and the behaviour of this employee, who is a Labour party candidate in a by-election. I hope that when he returns to his job at the Bank of England after that by-election, as I am sure he will, someone will have a word with him.
Andrew Bailey: It is not our intention to get involved in party politics.
Danny Kruger: Indeed not.
Siobhain McDonagh: It is Danny’s.
Danny Kruger: Well, I think it is important as a public body that that they maintain strict impartiality, and I am glad to hear that the Governor agrees.
Andrew Bailey: I do.
Q887 Danny Kruger: Thank you, Governor. A former chief economist at the Bank, Andy Haldane, was quoted this weekend saying that in his view quantitative easing had gone on for too long and that there had been too much of it during the covid crisis, with the result that the unwinding of QE has now had to be too sharp. Do you share that analysis?
Andrew Bailey: I read what Andy said. He said—I think he was very careful to say this—that he had hindsight. That is true, of course; he does have hindsight, and as he knows well, because he is a former member of the MPC, we do not have hindsight at the point when we make policy decisions. We have had this question, I think, at quite a few hearings in the Committee. I do not enter into those judgements about hindsight because it is very difficult then to separate out the hindsight judgement from the decision at the time. But whatever you think about the hindsight decision, I would say that going back to that point in time—I think Andy was referring to the last phase of QE that we did, not the QE we did in 2020 when I think he made the point that stabilising the economy was of critical importance—we did it on what we tend to call risk management grounds. It was not a big flow of QE at that point; it was quite a small flow of QE, relative to what we had done in 2020. But our concern was that with a lot of uncertainty still around the situation with covid, it provided a degree of insurance against volatility and a rise, particularly at the medium part of the yield curve, which had been a problem in 2020. Most of the people who give evidence on this—I think Charlie Bean may have said this at one of the hearings—say they do not think it made a major contribution to inflation. But it was done on risk management grounds.
Danny Kruger: Understood. Thank you. In terms of the QT, however, you are now selling bonds back at a loss, which of course the taxpayer carries. Are you content that the rate of selling is appropriate? Is the price you are getting fair from a taxpayer’s point of view, or do you not regard that as part of your remit?
Andrew Bailey: May I draw a distinction between what is called the cash flow and the overall cost-benefits of all this? The latter is a much bigger calculation, which has to take into account the economic effects throughout its life, and the situations that we have had to deal with.
Our objective is to reduce the balance sheet over a period of time. We do not want to cause what I call market disturbances doing it, and I think we have not done that so far. We are about to make a decision at the next meeting on what we are going to do for the year ahead, which we will consider in the meeting round to come. At the moment, I do not consider that that is causing market disturbance.
With the cash flow, of course, we will see what it is in the end, because it will take a long time to happen. That will depend on where the yield curve is throughout this period, and what the level of interest rates is throughout this period.
Q888 Danny Kruger: We are talking about selling at a loss. The taxpayer has to pick that up.
Andrew Bailey: At the moment, there is a negative cash flow. Of course, there was a positive cash flow for a long time for QE, which did not get commented on at the time.
Q889 Danny Kruger: Okay. The other thing that Andy Haldane said was that he feared we were on the edge of recession. I am interested in your view or perhaps colleagues’ views on the likelihood of a recession. It would be pretty catastrophic both to be in a recession and have inflation at high levels. We might expect inflation to be low in a recession. Governor, you talked earlier about your expectation of a marked reduction in inflation in the second half of this year, but of course you were predicting that earlier in the year, too. What do you think of this question, which other colleagues might want to answer: how close to a recession do you think we are?
Andrew Bailey: May I make two points? I will shut up then, because I have said a lot, and will let others come in.
At the last hearing we had, on monetary policy, there were some questions about where we were relative to the forecast. Relative to the May forecast, we are within 0.1% on inflation—
Chair: But you are just over 1% higher than the one right after the invasion of Ukraine—the out-turn now is 1% higher.
Andrew Bailey: I am talking about May this year, when you asked me previously. In the May forecast, the July figure would have been 6.9%, whereas the actual figure was 6.8%. In the past year, we have not had the degree of shocks that we had following the invasion of Ukraine. In that sense, I think inflation is coming down and our short-term forecast is performing better. I should say that it is possible that we will get a tick up in the next release, because fuel prices went down in August last year and up a bit in August this year, but I do not see that as essentially changing the path. Actually, that is in our forecast.
On the recession question, the August Monetary Policy Report does not include a recession, but I am the first to say that it has a very weak growth path in it. Growth is just above zero throughout, so it is a weak path for growth.
Q890 Danny Kruger: Yet you have just raised rates again. I invite Dr Dhingra to comment on this. You have been voting for no change in the Bank rate since it was 3%, and you again voted for no change this time. Why did you not vote for a cut when, as the Governor said, we are seeing very low growth at the moment?
Dr Dhingra: My decision was based on demand in general and activity being weak, so we do not need to tighten to the extent that we would otherwise have done. As to why I have not voted for cuts as opposed to going along with the committee, what has not really been appreciated enough in the media and the financial markets is the duration of keeping our policy in tighter territory. That trade-off between how high we go and the duration of staying high is fundamental.
My preferred policy, which now is not something that will happen, would have been a more moderate rate, so that we did not see a mountain shape, but something that is much smoother, with a much more balanced transition. If you are coming up for renegotiation with your lenders now, naturally you are exposed to much higher rates than you would have been had it been a more moderate path. However, that also implies that the duration would possibly have had to be longer.
Q891 Danny Kruger: With the gift of hindsight, are you content that the committee was right to make the rate rises that we have seen in recent months, or were you right to have proposed a hold?
Dr Dhingra: I would say that it is certainly somewhere in the middle. The one relatively positive bit of news that came between December and February was that energy prices and their increases unwound much faster than most of us thought. At that point we were still thinking about energy shortages, which could have had a really big impact on the economy. Fortunately, that did not happen. I think that is the reason we saw some pick-up in activity. That would then mean that, yes, maybe somewhere in the range of where the February vote was that I went with would have been appropriate from my point of view.
Q892 Danny Kruger: You mentioned the duration of high rates, but as I understand it the market expectation of the Bank rate is now to be higher—6% next year. I appreciate that you do not want to make predictions at this stage—you want to wait until your next meeting—but I would be interested in views from the panel on that prediction of 6% going into the end of 2024. Perhaps from Sir Jon?
Sir Jon Cunliffe: If I may, I will wind the clock back a bit and talk about what we have learned over the past year. We have learned that the economy was more resilient to the cost of living shock, if I can put it that way, than had been anticipated. Some of that is the downside surprise in energy prices, and some of it Government support, but you may find that some of it is just that the level of activity in the economy has been higher than we thought. I think those ONS revisions, which only go back to 2021, will roll them forward, but if the growth rates are the same, we would expect the level of GDP to be higher than the official data was saying. We were reflecting that in February and May—I can say a bit about forecasting models if you would like, Chair—and we were reflecting that with judgments of higher activity and more resilience in the economy. The risk, which goes back to your point, Chair, about non-linearities, which we were talking about in the committee from November when Huw Pill—
Q893 Chair: November?
Sir Jon Cunliffe: November ’22. We were talking about multi-applicative effects, and that the combination of a very tight labour market held up by strong activity and very strong externally-generated price pressures could lead to catch up and second-round effects that would drive inflation high. For me, what we learned over the first half of this year was that that risk—I think that risk was reflected in how the committee as a whole set policy—was starting to crystalise. We had a very big upside surprise in pay between the May forecast and the June meeting. We had an upside surprise in service price inflation.
Q894 Chair: Can you say which year?
Sir Jon Cunliffe: Sorry—June this year. In June this year we raised rates by 0.5%. There was a split vote on the committee, but the vote was to raise by 0.5%. That was in the light of a 0.5% upside surprise on private sector pay and a surprise on service price inflation. These are things that the committee has said indicate persistence, and that is where we come into next year and the forecast going forward. That led the committee as a whole to the view that we would need rates at a higher level going forward to contain the risk that had crystallised. We had a similar vote in August, but not to the same degree. The committee said it would look at the labour market, wages, and service prices as key indicators of persistence—so how long these inflationary, domestically generated inflation pressures go on for. For me, the vote in September—I can’t tell you how I am going to vote, and we have more data to come—will depend in part on that. We are getting mixed signals now. We are still getting strong pay, growth and service price inflation, but we are also starting to see some cooling in the labour market. That will be the kind of discussion going forward.
Q895 Mr Baron: As you know, Governor, some of us on this Committee have been quite critical of the Government’s interest rate policy in the past. Before one is accused of the benefit of hindsight, some of us were writing about this at the time, as I think you know. I put it to you that what we have at the moment is a situation where, because the Bank of England was so far behind the curve on inflation, we have had the most aggressive tightening cycle since the Bank’s independence in ’97. You are in the process of playing catch-up now, and interest rates may be a bit higher than they otherwise would have been had you been more proactive earlier in the curve, when there were clear signs of inflation. This is hurting people. At this time of a cost of living crisis, it really is impacting. Having got to this peak after a very aggressive rise, it doesn’t allow you the time to pause to see what effect your interest rate rises are having, and I would suggest to you that the follow-on from that earlier conversation with Mr Kruger is that you risk overtiming. Given the time lag with regard to interest rates and their effect on the economy, what you need to do is pause, typically and certainly for three months, but sometimes for six months and sometimes for nine months—we are seeing that with fixed-rate mortgages. What would you say to that charge?
Andrew Bailey: I would pick up on something Jon said. First of all, what I am about to say is not a comment on what we are going to do at the next meeting. Obviously, that is very much to be decided, so this is a more general comment.
I think we have discussed this before, but I disagree with you on the catch-up point because of the nature of the shocks we have had, particularly the shocks we had last year coming from the Ukrainian war. I think we have moved from a period when it seemed clear to me that the rates needed to rise going forwards and the question for us was by how much and over what timeframe. We are not, I think, in that phase any more, and that’s why we shifted our language to being much more evidence and data-driven to start with. That was important. We also introduced in August, very deliberately, the point that we think that policy is now restrictive in its impact.
I say that because I think the judgment is now much finer—and I understand your point. I think we are much nearer now to the top of the cycle. I am not saying that we are at the top of the cycle, because we have a meeting to come, but I think we are much nearer to it on interest rates, on the basis of current evidence.
To finish, Swati made an interesting point. By the way, the 6% today is five points; the market has come off a bit, so it is 5.75% today. The average interest rate difference between holding it flat for three years, which is our forecast, and the market curve is about 0.25%. It is not a very large number, and that is because one of them goes up and comes down while the other one stays flat, so the up/down is about 0.25% higher on average than the flat. One of the questions we obviously consider and will have to go on considering carefully is whether there is anything beyond that 0.25% average difference in putting them up and bringing them down again, or, as Swati said, is the holding constant path, once we feel we are at the right level—I again make the point that I am not making a comment on the next meeting—the right thing to do? That will be an important judgment that we will have to make. You make a point that is very much in our thinking as well.
Q896 Mr Baron: Can I broaden this out a little by moving on from where interest rates are at the moment and looking back a bit at lessons learned? I know that Ben Bernanke is coming in and you are having a fundamental review of your modelling process. I want to get an indication from you about how meaningful this is going to be. The Chair quite rightly raised the issue of recency bias. Any look at 100 years of inflation would have told you that following a spike into double figures it would take at least two years to return to pre-spike levels. That lesson is there in history, because inflation gets embedded—that point was raised earlier—but it doesn’t seem to have been taken on by the MPC. History is important, but I would also suggest to you that money supply is important. It is not a direct relationship, of course, but it is a bit of a coincidence that we had a massive spike in money supply at the beginning of the decade and then, within a pretty fast time afterwards, we had a spike in inflation. How broad ranging and meaningful is this review going to be, or are we just going to see—I ask this in the nicest possible way and hope you don’t take it personally, because it is a criticism of central banks generally—a little more groupthink?
Andrew Bailey: First of all, there are no constraints from us on the work that Ben Bernanke is going to do. I can assure you of that. I am very, very pleased that he agreed to do it. He is eminently well qualified to do it. Of course, we will not constrain it, and I can’t imagine he would have accepted if we had done that. There is no question of that. It will go where it goes, as it were; he is very much in control of that, and that is as we want it. There is no constraint from the point of view of the approach of the committee or the Bank executive. We are very eager to do this.
Of course it is important that we learn from this. There have been some huge shocks to the economy and we can learn a lot from this, so I can assure you there are no constraints.
Of course, I would not presume as to what you want to do. I have said to him, because I wanted to make it clear before he accepted, that you may well want to speak to him. It is obviously up to you whether you do, but I wanted him to be eyes-open. Now, he has done Congress a lot, so it wasn’t at all an issue for him. But obviously that offer is there if you wish to take it up.
Q897 Mr Baron: On the appointment itself, let us be clear that Ben Bernanke does not come without a little bit of concern in some quarters. No one can question the economic CV, but he was chair of the Fed and did not see any financial crisis coming along—neither did his team. He invented the concept of quantitative easing, and I think there is strong evidence to suggest that the second round of quantitative easing has, partially at least, resulted in an inflationary spike. I know you were party to this decision, but I put it to you that the concern that some of us have is that the appointment would not challenge the group-think mentality that bedevils not just the Bank of England but central banks generally.
Andrew Bailey: If you look at Ben Bernanke’s career, he is a very eminent monetary economist. He really is.
Q898 Mr Baron: One is not questioning the economic CV; you cannot fault it. From an economist point of view, he has ticked all the boxes. The trouble is, and we as a Committee have raised our concern about this with you before, there is too much group-think among economists generally and central banks—not just the Bank of England, although I think the Bank of England has been a bit too far behind the curve, for reasons that we have previously discussed—with not enough people questioning the norm. There has not been enough black-box thinking.
Andrew Bailey: I reiterate that the offer is there, and if you wish to ask him that question when the moment comes, I am sure he will be happy to answer it. I think that is the best thing I can say on that. I do not think that it is right for me to speak for Ben Bernanke; he can speak for himself.
Mr Baron: Thank you.
Q899 Dame Andrea Leadsom: I would like to talk a bit more about the risk of over-tightening. Sir Jon, the UK services purchasing managers index fell into negative territory and to its lowest level in 31 months in its last session, and your own agents on the MPC are warning about “weaker sales volumes”, “falling revenue growth” and interest rates, and how uncertainty continues to “weigh on investment plans”—those are all quotes from your own agents. Do you see this as a necessary slowdown to stop inflation, or do you see this as a risk of over-tightening?
Sir Jon Cunliffe: The first thing I would say is that the evidence is mixed; we are getting mixed signals about the economy. That is what you expect when you come into periods where you might be close to turning points and the like. I reiterate what the Governor said about it being finely balanced. So, yes, the CIPS output index shows that. Curiously enough, the expectations index from the same survey is very positive. So we have a survey that is very negative about output now and very positive about output in three to six months’ time.
We do not just use one survey—this goes back to some of the Chair’s questions about a range of data. The other surveys we tend to look with do not have that read. At the moment, the Bank’s view—it is very similar to what was in the August MPR; it has not changed much—is that quarterly growth is around 0.25%. It may be that the CIPS survey is signalling that the economy is going to grow at a slower rate than that, but, as I say, other data suggest not.
Of course, the pay data lag the activity data; it takes time for all that to work through. Certainly, the labour market is cooling a little bit—unemployment is up to 4.2% from 4% in the August report—but, in my view anyway, we are still seeing quite a slow cooling of the labour market and the pressures on pay, those non-linearities—I call them multiplicative—which we saw as a risk and we now think have crystallised, are coming through.
I should say that my last meeting where I will be involved in monetary policy is in September, because my term ends at the end of October, so I will not be able to vote in November. The challenge for the committee over the next few months will be to read those two things to see whether we are going to get persistent inflation—because we need to bring inflation back to target—or whether we are getting enough cooling in the economy. If the question is whether cooling in the economy and the labour market is necessary, relative to where it would otherwise be, to bring inflation down, then yes, that is how monetary policy operates.
Q900 Dame Andrea Leadsom: Correct me if I am wrong, but it sounds to me as though you think the balance is still on the side of raising rates because the inflation is still persistent.
Sir Jon Cunliffe: I will look at the next set of data and make my decision. To answer the earlier question, I vote on my own basis, and I have voted against the majority in the past. I look at the data and reach a view. That is why we have nine members on the committee. I am not constrained by the Governor in any way in how I vote. I voted for an increase in August and a larger increase in June because I was worried about those persistence pressures, and the interaction of stronger demand than we had seen, with catch-up and people looking back to try to recover lost prices and lost wages from the inflationary period. I will look at the data, but we are clearly getting to a point where headline inflation is going down—as the Governor said, that will feed into people’s decisions—and we are starting to see some movement in the labour market, and cooling. We have not yet seen that in pay, but it will come.
Can I just make one point about forecasting and modelling?
Dame Andrea Leadsom: Quickly, if you would.
Sir Jon Cunliffe: It is very important to this point. We start with the model. All models are caricatures of real life. There is a suite of models; that is the starting point. But then the MPC itself puts judgments that change the model, and we have made some quite big judgments in the past about inflation persistence and the like. Finally, when we have the best collective view of the committee, which is our judgment on top of the model, the model keeps us honest. It ensures that there is a general equilibrium and we cannot just move things around. When we have done that, we then deal with risk.
Dame Andrea Leadsom: Thank you—I think we know how modelling and forecasting works. Are you getting to a point?
Sir Jon Cunliffe: The key thing is not what is in the model, or the suite of models. The key thing when you are going through periods that have movements in inflation that we have not seen before—not even in the ‘70s—is how the committee applies judgment and deals with risk on top of that. I very much hope that Dr Bernanke is going to look specifically at those areas.
Q901 Dame Andrea Leadsom: Thank you very much. Ms Stheeman, as a member of the FPC, do you have any concerns about financial stability with regard to the activities of the MPC and the risk of over-tightening leading to financial instability, such as we saw with Silicon Valley Bank?
Elisabeth Stheeman: Thank you for the question. On the FPC, obviously we look across a very broad range of topics. The FPC would be focused on seeing that bringing inflation back to target, especially if it is done sustainably, is consistent with bringing interest rates back to a sustainable level. In some ways it could be even worse if one wouldn’t do anything about it. That is why, as you have heard from MPC colleagues here, it is a very finely balanced decision. As you know, we as the FPC do not get involved in interest rate decisions. Having said that, we will obviously look at to what extent there might be any financial stability implications.
Q902 Dame Andrea Leadsom: Would you be concerned about the speed of interest rate rises creating financial instability? Is that something that you have discussed on the FPC?
Elisabeth Stheeman: We would look at a range of different issues. For example, with the last ACS—the annual cyclical scenario; the stress testing—the FPC would look at not just the path of interest rates but in particular the development of unemployment. As Sir Jon has already said, unemployment has been much lower than, for example, the stress test. The stress-test scenario includes a peak unemployment level of 8.5%, whereas current unemployment is just under half that, at 4.2%. The stress test would also look at other things, such as GDP rises. What is important from the FPC’s perspective is that the UK banking and broader financial sector is resilient to any shocks, and the last ACS has shown that the UK banking sector would be resilient.
Q903 Dame Andrea Leadsom: So you are not biting your nails and lying awake at night wondering about the next MPC decision.
Elisabeth Stheeman: Thankfully not. I have other things to worry about at night.
Q904 Dame Andrea Leadsom: Thank you. Dr Dhingra, in the latest MPC minutes, you warn: “Lags in the effects of monetary policy meant that sizeable impacts from past and recent rate increases were still to come through… Recent news in components of consumer and producer price inflation strongly indicated a downward trajectory for CPI inflation.” Do the latest survey results confirm your view?
Dr Dhingra: Yes. This goes back very directly to the question that the Chair raised about recency bias. I have looked at a range of producer price inflation indices as well as consumer price, and it turns out that even through the 1970s and the really high inflation episodes, these two things have moved very tightly together. There is usually a lag between when PPI moves and when CPI turns. CPI tends to lag the turning point in producer price inflation. Even when looking at the item level detail, you can see that almost every item in the basket has turned at this point. As we know, producer price inflation has fallen much more once you correct for the fact that the items that we produce are not really the items that we consume. You correct for that composition, and you see that the tight historical relationship is still maintained. My hope would be that that is a very promising sign that in fact we are going to see a downward trajectory for consumer price inflation.
Q905 Dame Andrea Leadsom: Thank you. The Monetary Policy Report highlights that firms have taken out annual and fixed-term contracts for supplies of food and energy, which of course has the effect of delaying the pass-through of wholesale price falls. Since monetary policy cannot do anything about that, is that another source of the risk of over-tightening?
Dr Dhingra: That certainly would be. This is one of the places where we are in some level of darkness, because we do not really know what precisely those lags are. Again, going back to the historical data, the 1970s and 1980s are not particularly informative in that respect because we did not have the kind of global supply chains that we have at the moment, and that has really clouded our judgment in terms of when we think the turning point should be and how long that should take.
That being said—this is one of the places where I differ from the majority of the committee—I do not find services price inflation and some of these other measures particularly informative because they have a huge amount of imported and energy content to them. If you think of the supply chain and the point at which they finally get that inflation coming through to them from, say, the border, that lag would be much longer for services producers, and therefore I would expect that to be a more late-cycle indicator than consumer prices or other measures of inflation.
Q906 Dame Andrea Leadsom: It sounds as though you still feel that we need to wait and see the effect of recent increases.
Dr Dhingra: Yes. This is a very sharp tightening in a very short span of time.
Q907 Dame Andrea Leadsom: Absolutely. Governor, would you comment on that? Do you have some sympathy with the view that there is a lot still to be seen from the very sharp rises in interest rates and that there is a risk of over-tightening?
Andrew Bailey: We definitely have a substantial amount of transmission to come. Of course, you have to factor in to what extent people anticipate that. They anticipate, for instance, that their mortgage payments are going to rise. That is a question in and of itself. One of the questions on the recency bias is that, for instance, the mortgage market has changed fundamentally, so we would not learn a lot by going a long way back in time on that point.
I think Swati makes an interesting point. The pass-through from producer prices to consumer prices on goods price inflation has been slower, but Swati is right: it is very dramatic on producer prices. We have negative producer price inflation now, if I remember rightly, in this country. The question for us is how long that pass-through is going to take. Of course, it comes back to earlier questions that the Chair and others were asking: if we have this longer delay, how much is that going to cause more persistent inflation? That affects people’s expectations as well, and we have to consider that every time. I would lean somewhat more against that than Swati would, but we are on the same page in terms of what the issues are that we are trying to come to terms with.
Q908 Dame Andrea Leadsom: So you do accept that there is a risk of over-tightening here.
Andrew Bailey: What I would say is that it appears that there is a longer transmission. The lags are longer—this is the asymmetry point that Jon was referring to earlier—and we have to factor that into our policy decision. If you look at the inflation profile in the Monetary Policy Report, it comes back to target—on the modal case it may go a bit below target—and we are having to judge the risk around that all the time.
Q909 Dame Andrea Leadsom: I realise that, but I am asking you if there is a risk. It sounds to me that you are accepting that there is a risk of over-tightening.
Andrew Bailey: Look, there is a distribution of possible outcomes around any central path. The central path returns us to target.
Q910 Anne Marie Morris: Can we turn to the impact of the monetary policy—the tightening policy—on investment and trade for businesses? So a bit further down the food chain, if I can put it like that. Sir Jon, what impact on investment are we seeing in the way businesses are now making decisions? Are we seeing higher costs of borrowing? Are we seeing lower availability of lending? Are we seeing lower profit or lower demand? Taking all that in the round, how is that impacting the timing of businesses deciding whether to invest and, ultimately, growth?
Sir Jon Cunliffe: We are seeing some tightening of credit conditions, so the question of the supply, but in a way that is what you would expect when interest rates are up and growth is low, so banks and other lenders are taking risk-based decisions. I do not think we are seeing anything like a credit crunch at the moment, if we come on to that. At the same time, we are seeing businesses slowing investment decisions because interest rates are higher, so the hurdle rate for investment is higher. One of the channels through which monetary policy works is that it slows investment and business activity. I come back to this question of cooling in the economy. That, to some extent, is what you would expect.
In terms of indebtedness, which is slightly different, we are seeing in terms of net debt to income in aggregate that UK corporates are very strong. If we look at interest rate cover—the ratio of revenue to debt service—we are seeing a rise in more indebted companies, which is again what you would expect to see when interest rates go up because debt service is going up, but nowhere near the levels we have seen in past peaks.
Where there may be a more acute problem—the July FSR recognises this—is smaller businesses. We have less information on them because they do not have to file the same detailed accounts as larger companies, but we are seeing some evidence—we are getting some of this from the agents as well—that within the SME sector, demand for lending is going up a little bit and supply of lending may be constricted a little bit.
If I look at it from the macro, top-down, the Bank’s forecast for investment over the next two years is very low. My recollection is that investment was running at something like 3.5% to 3.75% a year in the pre-covid period, and we have seen lower investment in the UK since the middle of the last decade. I would have to refresh my memory on the forecast for investment growth going forward, but I think it is 0.2% or 0.3% next year and the year after. We are forecasting that business investment will be one of the channels through which monetary policy works.
Q911 Anne Marie Morris: Is there a risk, then, that we damage business confidence such that growth is not just temporarily dampened but that there is a long-term hit to the economy in terms of the growth that we might otherwise have seen?
Sir Jon Cunliffe: It is important to step back a little bit and say, “If we wind up with persistent inflation, persistently above the target in this country, that will damage business confidence an awful lot more.”
Going back to your point, Chair, one of the reasons why I think the control of inflation is so important is not just because of the tax that it imposes but because it distorts price signals in the economy, it makes investment decisions much more difficult, and it increases macroeconomic volatility if you wind up with persistent inflation.
So, if I was thinking about business confidence going forward, I think business confidence is served best by macroeconomic stability and a sense of confidence in the monetary regime and the fiscal regime, because those are the two frameworks that allow businesses to invest with confidence about the future.
On business, going back to that CIPS survey, business seems to be a bit more confident going forward than it is at the moment, based just on that one survey. However, I think that the worst thing to do for business confidence would be not to let monetary policy operate in order to bring inflation back to target.
Q912 Anne Marie Morris: Thank you. Ms Stheeman, can I now ask you a question about debt? We talked a little bit about this with Dame Andrea. On financial instability, the debt servicing costs are going up and insolvency rates are going up. Given the comments made about the different levels—you know, your FTSEs, but then you have your SMEs and then the micros—what sort of a risk to financial stability is this increase in insolvency and increase in debt servicing costs? Which piece, if you like, of the hierarchy is going to be most impacted and how damaging is that going to be on our economy, particularly when we then have to move to the upturn—hopefully—in the future?
Elisabeth Stheeman: I think you make a really important point, because obviously that is something that the Financial Policy Committee is very focused on. Just adding to what Sir Jon said, on the SME front, although we do not have as much information as we would like, what we found out following the pandemic, or during the pandemic, is that a lot of SMEs actually had not borrowed before and then they accessed the Government schemes. And the one number we do know is that about 70% of SME debt is floating. Coming back to what Dr Dhingra said about the pass-through, that obviously means is that once that flow comes through, they could potentially be more impacted.
That is less the case in larger corporates. First, they have broader access to debt. One of the things that I do as an external FPC member is that I am spending time in the regions. I was in Bradford and Leeds in Yorkshire earlier this year, and then I was in the north-west earlier this summer. And what came through very clearly is that there is a big focus on continuing access to lending. One of the organisations that I spoke to, together with the regional agents who set it up, is one of the lenders that particularly focus on SME lending.
I do not know whether you were interested in households as well, or is it just corporates you wanted to talk about?
Q913 Anne Marie Morris: Tell me about the households.
Elisabeth Stheeman: Okay. Obviously, obviously in terms of the debt servicing ratio or DSR, households is something that the FPC has looked at very, very closely. What gives us some reassurance there, comparing this with the 1990 crisis and then more importantly to the global financial crisis, is that far more mortgages these days are fixed rate.
Chair: We will have more questions on households later on.
Elisabeth Stheeman: Okay. I just wanted to make sure that I cover what you wanted to hear. That's fine.
Q914 Anne Marie Morris: When you say you do not have very much information on SMES, or not as much as you would like, how will you fill that gap going forward given the risk, because by volume they represent quite a large chunk of the economy?
Elisabeth Stheeman: That is something—and I will let others come in—that certainly as a committee we have asked staff to look into. Again, the regional network is incredibly important because regional agents will have access to companies directly. For example, at every pre-briefing before the FPC round starts, they will report back, and if we have a specific question, we can, for example, go to staff and to the regional agents and say, “Okay, can you find out more?” But given that they do not have as much information to lodge at Companies House, it is harder.
Andrew Bailey: I would just add that we do our own credit conditions survey every quarter. We also have access through our supervisors and the PRA to all the banks’ lending book information, so we can put that to work as well.
Q915 Anne Marie Morris: Finally, on currency, strengthening the currency helps, but given where we were, is it that much of a help? What has been the impact on imports and exports? Maybe Mr Bailey would like to take that one.
Andrew Bailey: We do not target the exchange rate—let me be very clear on that—because that is not our objective. You are right, of course, that a movement in the currency will have an effect, but of course all movements in exchange rates are relative movements—relative to other regimes, as it were. Nearly all central banks are tightening monetary policy at the moment to not dissimilar degrees. The exchange rate has strengthened over the last 12 months—that is certainly the case—but, as I say, we do not target it. We take it into account, obviously, because it is an important part of the transmission mechanism of monetary policy.
Q916 Anne Marie Morris: Okay, so you take into account, but you do not monitor what its impact is, which is different.
Andrew Bailey: Well, we—
Dr Dhingra: May I add something to that? I have worked on exchange rates in the past in particular. Typically, you would expect, and this is the old estimate, that a 1 percentage point increase in sterling would translate into a 0.1% decrease in the consumer price. Broadly, we are roughly in that ballpark as well right now. If you think of what happened in terms of this year’s 6% increase in sterling, if you look at what the fraction of the import basket is in consumption and at how much is priced in dollars, euros, everything else, and therefore how much the currency matters, you would come up with a number somewhere in the range of 1 percentage point or less. It has had an impact on CPI, but it is not big enough that you would think that that is going to change from where we were to something very dramatic.
Q917 Sir James Duddridge: Before I come to the Governor and talk about savings, I am more familiar with your work, Sir Jon, in Brussels and in the Cabinet Office, but you have a vast amount of experience, and this is probably the last time you will be before the Committee. What are your reflections and advice to future committees and, indeed, ourselves?
Sir Jon Cunliffe: First, I have been involved with the MPC since its launch in 1997 and was involved in the legislation that launched it. I think the system we have of a nine-member committee—the Governor was saying something about this—and voting and transparency has served the country well. In terms of the monetary framework, I think the MPC will always need to deal with new challenges, and one can think about reviews of the mandate or reviews of the remit and the like, but the underlying framework is a solid one.
Q918 Sir James Duddridge: Just to challenge and push you a little bit more, what is the one thing you might change or the one thing that both the committee and those who govern it should look at?
Sir Jon Cunliffe: First, I think the committee and the way it proceeds always needs to think about change and about whether it can do things in a different way. I talked a little bit about the Bernanke review. Different central banks do forecasting, and take forecasting into policy, which is the important thing, in very different ways. We publish a committee forecast; the ECB does not. The Fed has a different model.
The world of central banking has not been as ordered and sedate as I hoped when I joined the committee in 2014. We have had some really big shocks over my period in the committee. It may be that the world economy is just becoming more volatile—geopolitics come into this—and subject to bigger shocks. The ’70s is relevant, but we have seen shocks and a pandemic—we have not seen a global pandemic since the 1920s—and how you navigate through periods of extreme macro change and pressure is a real challenge for central banks going forward.
Q919 Sir James Duddridge: Thank you, and good luck going forward. I am sure you will be close to things, as you have been in the past.
Governor, can I take you on to the savings rate, which is of particular interest for constituents? The August MPC report noted that, as the base moves to 3.75%, the interest rate on the average account is only 1.8%. Clearly, there is going to be some margin there for the banks, but this seems excessive. What is the right margin and why are those rates not being passed on?
Andrew Bailey: That is an interesting question, thank you. Over the last couple of months, we have seen quite a pick-up in the pass-through to sight deposits. The pass-through to term deposits has been faster throughout—that is the six-month, one-year deposits—but we have seen a pick-up in the pass-through to sight deposits in the last couple of months or so. We have just seen the most recent monthly numbers.
I hope that means that we are into a new phase, as it were. I am happy to speculate a bit about why that might have been. If you go to the sort of more fundamentals, the story I would say is this. Pre financial crisis, there was a fairly settled relationship between deposit rates and our official rates; they were somewhat below our official rates. When the financial crisis happened and the Bank cut interest rates nearly to zero, the banks did not reduce their deposit rates to nearly zero, so they sat above our rate, obviously, over the last decade or more—for 15 years now. We have seen that revert to its previous relationship as we have rates now back up to their normal environment. We have obviously been through a period where that reversion was happening. The committee was right to highlight what was going on at that point.
I am more reassured by the fact that, of late—on the very recent numbers—we are now seeing more full pass-through, because, clearly, you cannot see that discrepancy just going on forever, because then the net interest margin is widening forever. I hope that what we have seen is a bit of a structural adjustment—with some encouragement from the sides—which will now put us into a different phase where the pass-through is more balanced.
Q920 Sir James Duddridge: Are you concerned about customer intransigence, in terms of rates? Those are people taking active decisions. I am almost more worried about the constituents that do not come to see me to complain about this—the ones that are just sitting on really low rates. In previous evidence, Barclays, the company that I used to work for, seemed to be a particularly bad offender, so I slightly regret that being the position. Of the big four, Lloyds bank were offering 1.4%. Santander is described in my notes as a “challenger bank”’—I am not sure that is how I would describe them. The figure is still pretty pathetic—at the highest, 2.5%. Do we think that that is acceptable? What are the impacts of that, not just for consumers? Let us face it: why bother saving at those negative interest rates?
Chair: Santander brought in quite a good instant access rate, according to newspapers.
Sir James Duddridge: I have 2.5%, which I do not think is particularly good. Maybe they have a better rate coming up.
Chair: While stocks last.
Andrew Bailey: I would stress two points. Obviously, competition is important, and transparency is important. That is much more in the domain of the FCA and the FCA is doing things—I know you have regular hearings with the FCA, so I will leave that for those. But I think it is important that we have transparency for the reason that you give, which is that we may think that the aggregate position is looking better, but the distribution could be quite skewed and there will always be people who are not aware through the normal channels, who do not look at or respond to the normal channels. The question of better transparency is important; I agree with you.
Q921 Sir James Duddridge: Presumably there is also the other side, of people who are taking decisions about what to do with their money. They have got an extra bit of cash in their pocket and instead of putting it into a savings account, which will then free up liquidity for investment, they are doing something else with that money, either something much riskier or something much more passive—just spending it. Do you have a view of the impact of that margin being wide on broader behaviours within the macroeconomic situation?
Andrew Bailey: Well, what they do with it will not necessarily affect the stock of money. It would, in a sense, get deposited by somebody else somewhere else, potentially. In terms of general equilibrium, it is not quite so straightforward as that. There will always be an effect. Different people will always take different choices, and we also want, obviously, a degree of—this goes back to the point that Jon was talking about in terms of investment. We also want risk taking and investment. Part of that will come through the banking system and part of it will come through the non-banking system. It is important that we get that, because if we go back to the questions that we had earlier on what I might call the trend rate of growth and how we raise the trend rate of growth in the economy, then of course investment and productivity growth is important.
Q922 Sir James Duddridge: I want to change the subject slightly in the final few minutes. Clearly, while people at a bank should not have their bank accounts closed for political reasons, in terms of political parties or political individuals, we are also doing a report on sexism in the City. In that regard, it was very upsetting to see Alison Rose go, given that she was a pathfinder. What are your broad reflections on those bank account closures, but also on supporting everybody through careers in the City? Certainly when I was in the City, it was 80% male dominated. It is much better now, but what are the lessons to support this further?
Andrew Bailey: That is important. First, let me say—again, I make this point very deliberately, but I do not take sides—it is unacceptable to close bank accounts on the basis of people’s politics; it is absolutely unacceptable. And I say that both ways; I am not making a point either way. That cannot happen.
On the question of diversity, I agree with you. Both the regulators, the FCA and the PRA, are going to come out fairly soon with a piece of work on diversity and inclusion. I very much agree with you on this, and what I would say—because I am not sure this is always the sense you get in some of the reporting; it is a personal view—is that I think that greater diversity will actually lead to better decisions being taken on things like bank account maintenance. I think we really need to support this as a means to—when I say that, I am not—I really have no time for getting into the “woke” debate, whatever woke means; I do not really know what it means as a word. But this is not about that; it is really not about that. It is about having good decision making by institutions that are broadly representative of the country that we serve.
Q923 Siobhain McDonagh: I would like to look at mortgages, renters and the housing market; we have made a couple of references to them. August’s Monetary Policy Report tells us that we will not understand the full impact of higher mortgage rates for some time, because of the prevalence of fixed-rate mortgages and the delaying impact that that has on policy transmission. Your figures suggest that around 4 million households currently locked into fixed-rate mortgages will face increased costs before the end of 2026. I have a constituent who is trying to renegotiate his mortgage, and he has been told that if he wants to have a package for two years, the increase per month will be £400; if it is five years, it will be £350, and if it is 10 years, it will be £300 per month. In my reading of that, it suggests that high mortgage interest rates will be with us for some time to come.
Andrew Bailey: Well, the banks have to price fixed-rate mortgages off the interest rate curve today when they are giving mortgages. So on your comment that high mortgage rates will be here for a long time to come, that of course is based on where the interest rate curve is today. The interest rate curve in a year’s time may not be at that point. It will not be; it will be somewhere else, but we do not know where.
The banks, however, have to price them. They have to go into the interest rate swap market and swap it at whatever it is—two, five or whatever years—so they are pricing off the curve. That is the way in which a fixed-rate mortgage market works. It is obviously different from a variable-rate mortgage market, because although some of the banks’ deposit base is at a fixed term, most of it is not, so they have to hedge that position to hedge their own interest-rate risk.
Q924 Siobhain McDonagh: How long will people be offered packages that are beyond the ability of most of them to pay? They just do not have that gap in their budgets.
Andrew Bailey: It comes back to the discussion we have been having about monetary policy. What I expect to happen is that as inflation returns to target, that will be reflected further out in the curve—but we do not know by how much, I’m afraid.
Q925 Siobhain McDonagh: If we now look at private renting, let me quote the Monetary Policy Committee in June: “The Committee also recognised that it had become more important to consider developments in the rental market.” That is nothing too outrageous on the face of it, but it is a shock to learn that it represents the first time that private renting has been mentioned in the committee. It explicitly referenced how that affects the transmission of monetary policy. Why the new-found interest in the private rental market as a challenge and as a way of dampening spending?
Andrew Bailey: Another of the structural changes that has taken place in the UK economy is that the rate of home ownership has declined over recent times, so the private rental market has become more important. More people are renting, and there has been the growth of the buy-to-let market. The other point I would make is one you will be very conscious of: the private rental market is not homogenous, but there is greater concentration of the private rental market in the lower household-income bracket.
Q926 Siobhain McDonagh: Are you worried that increasing interest rates has a disproportionate effect on people who are much poorer?
Andrew Bailey: I am aware of that. I am afraid that we have to do what we have to do on monetary policy, because—I have said this quite a few times before, and Jon was saying it earlier—if we do not get inflation down, the consequences are worse. However, I am conscious of the fact that the private rental market has higher concentration in the lower-income groups in society, yes.
Q927 Siobhain McDonagh: The private rental market is about 20% of households across the UK, but in my constituency in south London it is a third. The renters I speak to at my advice surgery every Friday are beside themselves about their futures and the possibility of keeping a roof over their head. They tend to be younger and poorer, to have more children and to spend an ever-greater proportion on their monthly rent than equivalent homeowners do, but without access to any of the safeguards or security involved in owning. London rents are outstripping wage growth as landlords pass on increased mortgage rates to their tenants.
Meanwhile, no-fault evictions are at their highest since 2017. When we see court staff back next month, hell will break loose in lots of London councils as buy-to-let landlords want to sell their properties. It is a precarious position to be in for families who have real difficulties. The safety net is falling apart, with fewer social housing units—in my borough, in the past year, only 37 three-bedroom properties have been available to let. In England, 99,000 families are currently in temporary accommodation, and that cost the public purse £1.6 billion last year. To go back to the point, are you concerned that the transmission of monetary policy is disproportionately impacting on a group of people unable to fight back?
Andrew Bailey: I am concerned about these impacts, because it is important. I cannot comment on housing policy, although there are obviously questions there, but I can tell you that I spent some time on one of my regional visits, as Elizabeth was saying, at Citizens Advice in Exeter. I met people in exactly that position and talked to them. I know that those no-fault evictions are very difficult for people.
Q928 Siobhain McDonagh: Are private renters just becoming collateral damage?
Elisabeth Stheeman: I just want to add that I had a really interesting roundtable when I was in the north-west with a group of housing associations and small private rental providers, and they certainly felt it was very hard for them to keep up with some of the regulations and everything. Obviously, as the Governor said, we would not comment on housing policy, but it is certainly very clear, and I’ve seen this in my own family. At the moment, we live in a four-generational household, and one of the reasons is that, for the youngsters, as you said, it is getting more and more difficult to find somewhere to live within a budget they can afford.
Q929 Siobhain McDonagh: Looking at house building, the number of new homes completed in the first half of 2023 was just under 110,600. That is the lowest figure in any of the last six years, excepting 2020 due to covid, and a year-on-year decline of 11%. We know that loan-to-value ratios for new build mortgages are less generous, so it is fair to assume that demand for new build properties will fall sharply as belts tighten even further, particularly given the end of the Government’s Help to Buy scheme. We also know that small developers, who, depending on your definition, deliver roughly a third of UK homes, will be disproportionately hurt by the increased cost of borrowing because they have less access to capital or the ability to land bank, and typically work on a project-to-project basis.
This is a very bleak outlook for house building in a country that already has an under-supply of more than 4 million properties. What assessment has the Bank of England made of the likely impact of sustained high interest rates on house building in the UK?
Andrew Bailey: Well, we look at it through the lens of housing investment, which is obviously, in many ways, a very similar thing, and you’re right: housing investment is weak at the moment because activity in the housing market is weak in turnover terms. I’m afraid that is probably not unexpected, given the cycle of interest rates. Again, obviously, the sooner we get inflation down and get some return to that normality, the sooner we will get greater confidence for investment. I think that is a point Jon was making earlier. Lowering uncertainty tends to raise investment in the economy—both business and probably housing as well. But I cannot comment on housing policy more generally because that is not our primary concern.
Q930 Siobhain McDonagh: Are you not concerned that this is a case where monetary policy to control inflation in the short term will come at the expense of worsening a housing crisis that could last for generations?
Andrew Bailey: I would just reiterate the point that if we do not control inflation, things will get worse.
Siobhain McDonagh: Can I extend the invitation for anybody here today to come to my advice surgery on a Friday?
Chair: Thank you, Siobhain.
Q931 Dame Angela Eagle: Governor, new lending at terms longer than 35 years is up from 5% in the first quarter of 2022 to 11% in the first quarter of 2023. That essentially keeps people indebted for longer: their mortgages last virtually a lifetime and they therefore incur a bigger interest bill. Have you, as a committee, thought about what effects that switch and that change may have on the economy in general?
Andrew Bailey: We do look at it from the point of view of the transmission mechanism of monetary policy, so I agree with you on that. Again, putting my old hat back on momentarily, I think it is for the FCA—who do have policies because I remember them being introduced—to ensure, particularly if people are taking mortgages that are likely to extend into retirement, that they are affordable. That is important.
Q932 Dame Angela Eagle: But many people now have little choice. Given the different ratios between average wages and the cost of a house, they can either do that or face life in the private rented sector, which, as we’ve just heard from my colleague, can be very stressful: you have very few rights and are subject to no-fault eviction at a few months’ notice.
Andrew Bailey: I think there is a balance to be struck here. The flexibility to extend mortgage terms is not necessarily a bad thing for some people at all. It is not a bad thing, but clearly it is important to watch that it doesn’t become embedded in a way that, for some people at least, it becomes difficult. And of course, the problem will emerge much later on.
Q933 Dame Angela Eagle: I wondered whether you had thought or whether there was any work being done on the implications for that in the context in which you work, which is the macro-economy?
Andrew Bailey: Our role in this sense, from both the monetary policy and the financial stability side, is to take account of how it works with the monetary policy transmission and whether it affects financial stability. I would say that on financial stability I do not think it is big enough to really register on that scale. However, I think the FCA has a very important role to play here in terms of the conduct of these arrangements, which I know they are very aware of.
Dame Angela Eagle: We see the FCA regularly, and rest assured that we do ask them questions about this. On the transmission—
Andrew Bailey: I think Jon wanted to come in.
Sir Jon Cunliffe: There is a financial stability issue here as well. Just a general point: the underlying driver of house price to income growth in the end comes down to supply and demand for housing. The Bank of England cannot deal with that. Our housing tools—the measures we brought in in the FPC—limited the amount of debt to income or the flow of higher debt-to-income mortgages. One of the reasons why we have been able to go through a period of very sharp monetary policy increases without creating the sort of housing crisis we saw in the 1990s, or some of the impacts we saw in the financial crisis, is because, actually, household debt to income is lower than it was. Of course, households were tested by the FCA and the Bank as to whether they could service their debt at a higher rate.
From a financial stability point of view, if the answer to people not being able to afford their houses is that they borrow a lot more relative to their income, then you induce a volatility in the macro-economy and in financial stability, which at the moment we do not have. There are questions about the financial stability risk of the mortgage increases, and the FPC’s view is that the mortgage increases are clearly having an effect on people, but not a financial stability effect. One really has to tackle the underlying issue here, which is about the supply and demand for housing.
Andrew Bailey: I would add that financial stability is a backdrop. We have a banking system that is in a stable condition, and the agreement the Chancellor announced with the banks on the mortgage concordat can be done when you have a stable financial system. Also, as Jon was saying, the repossession rate is now nothing like what it was in the early 1990s, and that is a good thing.
Q934 Dame Angela Eagle: I don’t disagree with you about that. I think, though, that if we also look at banking resilience as a part of the financial stability that you have to consider, we see that bank profits have risen very substantially in the last period, up to about £17.9 billion according to the figures I have seen. That is a 21% increase for quarter 1 of this year from the last quarter of last year. It is a substantial increase with strong net interest income. This ties into what my colleague Sir James was talking about earlier, which is the refusal or the slowness of the rate of pass-on. That damages transmission mechanisms and it enriches particular banks, which might even be accused of profiteering. That is a fair point to make, isn’t it?
Andrew Bailey: I would look at two things. I would look at it from the point of view of return on equity, because I think that is a more systematic way of doing it. I think for some banks—certainly quite a few—the return on equity is sort of around its long-run average now. Secondly, I would come back to the point we were making earlier in the conversation. I very much take the view, as I said, that there may well have been a transitional element to this as the interest rate regime changed, but obviously it cannot go on. If it went on permanently, I think we would have big issues.
Q935 Dame Angela Eagle: It is a very profitable lag from the banks’ point of view, isn’t it? That is, they have not passed through interest rate rises to their savers as quickly as they have increased the cost to their borrowers. They have made a lot of money.
Andrew Bailey: Net interest margins have risen. Again, if you look at them in the long-run context, they are probably back towards their long-run averages, whereas having interest rates at near to zero had moved that. Again, it comes back to the point about recency bias: what is the right basis for comparison here? Is it the post-financial crisis period, when we had an extraordinarily low level of interest rates? Or is it the longer run? You will get a different story depending on which you look at.
Q936 Dame Angela Eagle: I suppose it could be said, given that you are responsible for financial stability, that you are quite happy with banks being more profitable, even if it damages the transmission mechanism. Is there a bit of a bias that way from the Bank’s point of view?
Andrew Bailey: That is why we do stress tests. We look for levels of capital in the system that we think are consistent with maintaining financial stability. In a sense, we have set that level. The stress test then tests against it and the banks pass the stress test. It follows from that that we are not seeking to see capital levels higher than that. That is not part of our objective.
Q937 Dame Angela Eagle: That is an interesting response because the stress test, which we talked about earlier, assumes that banks pass changes in the Bank rate through to retail deposits to a far greater extent than they actually have. Does that confirm that there are no financial stability reasons why the banks should not have been passing through Bank rate increases much more generously and quickly?
Andrew Bailey: It would be consistent with my view that the rate is increasing, and I am not surprised. There were a very good reasons why it should increase, so I think that is consistent.
Q938 Dame Angela Eagle: I would like to ask a couple of questions about broader financial stability issues. A year ago when we had the Truss Budget, we talked about improving the resilience of LDI funds—this crystallised issue with pension funds that nobody had really quite realised was there, which suddenly crystallised into a highly dangerous situation. Are you happy enough with the changes that have been made and the analysis of what happened to think that that has now been dealt with and that it is not going to happen again in a period of high stress?
Andrew Bailey: Jon may want to come in on this. There are two things that I would say have happened. One is that we set a level of buffer that we regarded as consistent with maintaining stability given the experience, just under a year ago now, of what can happen in interest rate markets. They are doing that and, when we had a much lesser degree of volatility but still some volatility earlier this year in the markets, they were able to absorb it very easily and deal with it. I thought that was encouraging, but of course it needs to stay there.
The second thing is the duration that it takes the funds, particularly the so-called pooled funds, to realise the assets.
Q939 Dame Angela Eagle: There was more of an issue with the pooled funds, wasn’t there?
Andrew Bailey: There was, yes, because of the collective action problem that is embedded in them. We have been very clear that they have to be able to realise this liquidity within that time because if they cannot, then they default. That was the situation we faced. Good progress has been made, but we have to ensure that it remains there. Jon, did you want to comment?
Sir Jon Cunliffe: We put the buffer in place. It was a kind of emergency buffer to deal with the gilt yield rise of 250 basis points and then, depending on the funds, something to deal with day-to-day movements between 50 to 150. That looks as if it would deal with a historical experience and something on top of that. That is being implemented now by the asset managers who manage those pooled funds. As the Governor said, they have managed to keep that buffer there. I think it is going to come into guidance from the Pensions Regulator, so it will become part of the system to have that liquidity buffer there to deal with it.
Equally important is ensuring that you can actually get the liquidity across between the pension funds and the pool funds. There are also some requirements for the number of days within which they should be able to get the funds across. It looks as if they are in a much more robust position for very sharp increases in gilt rates that generate liquidity calls than they were before.
Q940 Dame Angela Eagle: The Financial Stability Report warns that “the sharp transition to higher interest rates”—this volatility we have been talking about—“increases the likelihood that” market-based finance “vulnerabilities crystallise”. We just talked about that issue; do you have your eyes on any others?
Elisabeth Stheeman: Perhaps I can say something about real estate. As you will no doubt have been aware, commercial real estate is a topic on which many central banks around the world are very focused. Clearly, when there is volatility of interest rates, especially an increase in interest rates, it will be much harder for investors in real estate—for now, let me just focus on commercial real estate—to get the financing on the one hand, but on the other also to make it viable. That would certainly be one area that the committee has been very focused on.
The other one would be that volatility can obviously be a good and a bad thing for certain market participants. For example, another pocket of the financial sector in terms of non-bank finance—the hedge funds and that area—
Dame Angela Eagle: They thrive on volatility.
Elisabeth Stheeman: Well, yes.
Andrew Bailey: Up to a point.
Dame Angela Eagle: You might even say they cause it, but that’s a different issue.
Elisabeth Stheeman: You may be aware that the Bank, and in particular the Financial Policy Committee, has launched—this is another nice acronym—the SWES, or the system-wide exploratory scenario, which is looking particularly at non-bank financial institutions. Remind me, Jon, when that is coming up. You probably have it on top of your head—it is later this year, right?
Sir Jon Cunliffe: Yes.
Elisabeth Stheeman: You are seeing Sarah Breeden next week, and she will no doubt be able to talk more about that.
Dame Angela Eagle: I want to ask my final question to Sir Jon, given that it is his last time here and we go back rather a long way.
Sir Jon Cunliffe: We do.
Q941 Dame Angela Eagle: The Financial Stability Report highlights in chart 5.5 that “hedge funds have…built up large short positions in US treasury futures”. Can you explain the potential risks arising from that and what the UK can do to protect itself if they crystallise?
Sir Jon Cunliffe: This is the riskless trade that sometimes goes wrong. We saw this in the dash for cash. One type of relative value basis trading that hedge funds do is, basically, the asset managers want to have an interest rate future—an interest rate derivative—and the hedge funds buy the underlying Government debt, so they will buy a US Treasury or a gilt. This is mainly a US trade, so they will buy a US Treasury, which will pay out at maturity and so on, so in a way they have that interest rate flow. Then on the back of that they will sell a corresponding derivative contract to an asset manager. Generally, there should not be any difference between the underlying instrument—the US Treasury—and the derivative, which is based on the underlying instrument.
However, during the dash for cash there was a difference. The problem with this trade is that you do not make very much money on any individual trade, because basically you are trying to sell something while holding the thing it is based on, so it is very small margins. In order to get a return on that, you leverage up very, very highly. If something then goes wrong and, for some reason, the price of the derivative you have sold starts to diverge from the instrument on which it is based—which in theory should never happen, but it does—you suddenly get a very large margin call, because you have to pay the difference that is happening, and you also reach solvency issues. If you have borrowed money because you had to leverage up from your prime broker—your investment bank—to do that, and they start to get worried and cut off your lending, then you have to start selling the underlying instruments very fast.
The hedge fund industry disagree with me on this, so there are other views, but one of the drivers in the dash for cash—the US authorities have done work on this—which was not huge, but it was acute and very concentrated, was the hedge funds that were in these trades suddenly having to dump an awful lot of Government securities on the market. That is what helped to drive some of the spiral that we saw in 2020 in the crisis in funding markets, the US Treasury market and the gilt market. We are signalling that those positions have been built up again and that people are back in that trade. I think the answer to that is partly to do with the cost of the leverage to the hedge funds, from their prime brokers, which is something we have been looking at in this whole area of fund leverage that we are looking at internationally. There is an argument that in good times this trade anchors the price of the future, keeps it tied very closely to the price of the underlying asset and stops them ever moving very far apart, but in stress—sorry, this is very long—it can cause problems, and that is one of the areas we are looking at.
Chair: Thank you. John, I think you have a few supplementary questions.
Q942 Mr Baron: May I take us back to the issue of risk taking in an economy, which you mentioned, Governor, along with one of the objectives of the Bank of England being to support the economic policy of the Government when it comes to growth and employment—rightly so? I also refer colleagues to my entry in the Register of Financial Interests. We have a scenario where the regulatory authorities in this country seem to have gone into overcharge and are dampening growth and employment. I will give you one specific example, and maybe Sir Jon can come in on this, given his knowledge of financial matters. We have investment trusts in this country that have been conduits for tens of billions of pounds—
Chair: Do you want to declare your interests as well?
Mr Baron: Sorry, I thought I had declared my interests in the register. I am particularly interested in investment trusts, as you know. I apologise; I thought I had said that.
Investment trusts have been a brilliant conduit for investment in things like renewable energy, infrastructure, private equity and so forth, but they are now being disadvantaged by FCA guidance, which requires them to add their corporate costs—management costs, administrative costs, financial costs—to the fund manager charges, even though those costs are already captured in the share price, so that the market makes its mind up with regards to such charges.
We are now at the point where Britain is the only country in Europe that is retaining those cost disclosure rules. No other country in Europe is doing that. That double charging, in effect, of the management of the investment trust and the management fees for running a portfolio of trusts, is putting off investment. We have seen the amount of money raised through IPOs for renewable energy, infrastructure and many others absolutely decline, and discounts widen. Is that something you are concerned about? That is not financial stability; that is overbearing restrictive practices, to the point where we are the only country in Europe doing it. What is the Bank going to do? Will the Bank look at this?
Andrew Bailey: I am concerned, for the reason that I said earlier. We are very interested in the underlying growth rate of the economy and in the supply side of the economy, and that of course has to be supported by investment, which supports productivity growth. As I am sure you are aware, the Chancellor is very interested in this subject, and a number of initiatives are going on. I strongly encourage you to have that conversation, if you have not already. I cannot speak for the FCA, and I think this is one since my time—if I am wrong on that, I apologise—but I think it is important. We had the same issue with Solvency II. That is a well-known process, and we had to balance what I call policyholder protection with investment in the economy. Those are matters of judgment.
Q943 Mr Baron: I would like to bring Sir Jon into this as well. We know what is going on more widely. We have the Edinburgh reforms, the Mansion House compact and various things being looked at by various individuals, but still the Bank of England has a responsibility to encourage growth and employment—or to help the Government to achieve that, whichever Government they are—and yet the signalling from the Bank of England, if I may suggest this, has been somewhat weak.
The FCA is restricting what has been in the past a very growth-orientated part of our financial system. You will appreciate the importance of investment trusts to the economy: we have four investment trusts in the FTSE 100, for example, and 100-plus in the FTSE 250. They have done a great job in channelling money into growth areas, into important areas for the country such as renewable energy infrastructure, and yet the FCA has gone out on a limb—within Europe generally—to enforce a cost disclosure regime that is forcing investment trusts to do something that does not happen anywhere else. What is the messaging from the Bank of England on this?
Andrew Bailey: I cannot speak for the FCA. I think you need to raise it with the FCA.
Mr Baron: I know, but you are still responsible in part for regulation.
Andrew Bailey: I strongly recommend that you speak to the Chancellor who is very interested in these subjects. I will be honest: we have put our focus of late on the question of pension investment, starting really with the productive finance work that John Glen led, and going forwards, we will focus on how pension fund investment can be mobilised in the economy. But I take your points. There are more angles to this issue, and I would strongly suggest you raise it.
Chair: Thanks, John. I am going to bring in Andrea to get back to the subject at hand.
Q944 Dame Andrea Leadsom: I have just one last question: does the Bank of England, or the Monetary Policy Committee, consider any part of its remit is to avoid a recession?
Andrew Bailey: Our remit is to return and maintain inflation at its target and, subject to that, support the policies of the Government. Of course, those policies include policies on growth, investment and all the things we talked about. That is what we do.
Dame Andrea Leadsom: Okay. So, no, then.
Andrew Bailey: We are not seeking to create a recession.
Q945 Dame Andrea Leadsom: No, I am not really challenging you on whether you are seeking to create a recession, but it is just going back to the risk of over-tightening again. You may well create a recession. You do not know if you will create a recession and so your only objective is to get inflation down, not to avoid a recession. I am just really reflecting on your answers to my questions and wondering whether, under the terms of the obligations of the MPC, is it fair to say that because you have to get inflation back to 2%—that is your mandate—it is worth it to you to risk a recession because it is not part of your mandate?
Andrew Bailey: Let me answer that question.
Dame Andrea Leadsom: No, I’d like you to answer that question.
Andrew Bailey: I am going to. Let me illustrate it. We have certain flexibility over how quickly we return inflation to target. Clearly, that would have consequences in terms of outcomes for growth in the economy. We do balance that. Currently, we think that inflation will return to target somewhere just after the turn of the year at the end of next year. We are not seeking to do it more quickly because I do not think that would be optimal from the point of view of the path for the economy as a whole, so we do consider that; yes.
Q946 Dame Andrea Leadsom: I really would like an answer to the question. So you would not raise interest rates and risk a recession? You would not have in the back of your mind—
Andrew Bailey: We do have to make a choice. Let us say that, in a hypothetical world for a moment, we could return inflation to target at the middle of next year, or we could return it to target at the end of next year and there would be differential outcomes in terms of the path of growth in the economy and a recession; we would have to consider that very carefully, as we do.
Q947 Dame Andrea Leadsom: Dr Dhingra, what would your answer to that question be?
Dr Dhingra: I would actually say that a recession poses real risks to our inflation target in itself, so that is not something we would like to have happen at all.
Dame Andrea Leadsom: Thank you.
Sir Jon Cunliffe: Our remit is to hit the target sustainably—to bring inflation sustainably back to target—so if, for example, we were to create a recession immediately by very large increases in interest rates, then we would find inflation is below target at the horizon and our target is symmetrical. It is to keep inflation at 2%, caring as much about going under as going over. As Swati said, we have to balance those various things and that is why the forecast at the end always looks at where activity will be at the end of the horizon, but we want a sustainable 2% not just 2% at any given point.
Andrew Bailey: Can I just qualify that, if you don’t mind? If you go back to towards the later end of last year—just under a year ago—we were forecasting a recession because, with energy prices where they were at that time, I am afraid that our conclusion was that in those circumstances it was going to be very likely that that is what would happen and we could not avoid it. Fortunately, of course, the energy price story evolved in a very different way, so I agree with Jon and Swati, but I would emphasise that we cannot always say that we will avoid it.
Dame Andrea Leadsom: I understand, but my question was more about your motivation.
Dr Dhingra: To add one line to that, what the Chair raised earlier about non-linearities becomes really important at that point; it is very hard to get a handle on how quickly things deteriorate.
Sir Jon Cunliffe: The remit is actually clear about when we are in so-called “trade-off territory”—when we have to trade off the speed at which we bring inflation back to target relative to what happens to activity, the remit gives us the flexibility to extend that period to try to avoid that. There is a great speech by Mark Carney on lambda, if I can call it that, which actually explains how the remit delivers between those two things.
Chair: Anne Marie, I think you had a supplementary question.
Q948 Anne Marie Morris: Following on from the questioning about mortgages and the concerns that are rightly raised, may I ask this with regard to buy-to-let mortgages? Why is it that there is an obligation, when the product is created to build in a greater cushion for risk and therefore they are generally offered at a higher rate—I think the cheapest buy-to-let mortgage you can get at the moment is at 9%. But when you look at the data historically, there is no record of buy-to-let mortgages being riskier, with greater levels of default. So it seems to me that all you are doing by requiring that in-built cushion is increasing the risk that was referred to earlier of landlords rushing to the door and selling.
Chair: Anne Marie, just for clarity, do you have any interests that you want to declare in the context of this question?
Anne Marie Morris: I do have a property to rent—you’re absolutely right—yes.
Chair: Thank you.
Andrew Bailey: There are two things. First, they are much more heavily concentrated as interest-only mortgages, so on the whole the level of equity will be lower. Secondly—this goes back, obviously, to recency bias—we do not have a very long history of buy-to-let mortgages, so, again, the modelling that is done to create those risk weights has also to look at the risks. That’s where the two points come together, really—looking at the risk of having these mortgages with often much thinner levels of equity in them.
Q949 Chair: I have a couple of further supplementary questions that I was hoping that colleagues might raise. On quantitative tightening so far—you know that we have an open inquiry into quantitative tightening.
Andrew Bailey: Yes.
Chair: To what extent has the quantitative tightening that you have done so far tightened monetary policy? Do you know now what impact that has had?
Andrew Bailey: On the basis of what we have done so far, we do not think so, to any great extent. But the staff are working on the subject, so I will ensure, if you like, that any staff work that we think is useful we send to you.
Q950 Chair: Do you think that mortgage rates, for all the people out there who are worried about the increase in mortgage rates, are any higher because of the quantitative tightening that you are undertaking?
Andrew Bailey: No. That is, in a sense, saying, “Is the interest rate curve higher than it would otherwise be?” because as I was saying earlier, they are priced off the swap curve, so that’s the price. Our analysis would suggest that no, quantitative tightening has not contributed to any notable increase in the curve. But again, we will be happy to send you what—I will make sure you have got what we have done, so that you see the work that we have done on that subject.
Q951 Chair: So you do not think that the current level of mortgage rates is affected by the quantitative tightening programme that you are undertaking.
Andrew Bailey: I do not think so. I have to say that when we take our judgments on what we will do going forwards, if I felt it was, we would have to think very seriously about the implications of that.
Q952 Chair: Nearly a year ago, we went through turmoil in the mortgage market, and then things seemed to stabilise for a period. Nevertheless, mortgage rates today are similar to what they were in that period of turmoil. Is the level of mortgage rates today connected to your actions in terms of tackling inflation and raising rates?
Andrew Bailey: Can I go back to what I was saying a few minutes ago? As you said, just under a year ago we were expecting—we were forecasting—a recession. So we had interest rates at that level with a forecast of recession. As we said earlier in the hearing, the record and the evidence on activity in the economy have shown it has been much more resilient to that. But that does affect therefore, I think, the setting—it has affected the setting of interest rates and where the market is pricing rates, but, as Jon was saying, in a very different setting of a more resilient economy.
Q953 Chair: So the rates that those who are worrying about the increase in the mortgage amount that they have to pay—is that connected to the increases in rates that the Bank has implemented since last year?
Andrew Bailey: Well, I think the curve—
Chair: Is there a connection between the higher rates and higher Bank of England rates?
Andrew Bailey: Yes, there is a relationship.
Chair: There must be.
Andrew Bailey: Yes is the answer—
Q954 Chair: Come on, you’re not going to deny that there is a—
Andrew Bailey: No, no—because there is, of course. Let’s take a two-year fixed-rate mortgage. If you look at the relationship between our setting of Bank rate and the two-year fix, the two-year point on the curve, yes, there is a relationship. It is not a one-for-one relationship, but there is a relationship, yes.
Q955 Chair: But is the turmoil period just under a year ago still reflected in mortgage rates today or is this more linked to what you have had to do to tackle inflation?
Andrew Bailey: No, I think most of that came out in the months following, so the story that we are now seeing is much more about the resilience of the economy.
Q956 Chair: Okay, thanks. One final question then, which Sir Jon alluded to, about the ONS. They have revised up UK growth over the period in which inflation became so high in the UK by I think 1.8% cumulatively. If even the statistics authority cannot tell you what the current rate of economic expansion is, that must make your job really difficult. Or do you feel that your approach, which is obviously independent of what the ONS are doing, has correctly captured the level of current economic activity?
Andrew Bailey: Well let me say two things on that, then Jon or Swati might want to come in. First, I would just point to the fact that if you look at the three fan charts that we published—the GDP chart, the unemployment chart and the inflation chart—we actually have a fan on the historical period for the GDP chart. So we have a backdated fan for GDP but not for the other two. That is because GDP data do get revised, so there is uncertainty.
Q957 Chair: This was a big revision, wasn’t it?
Andrew Bailey: Yes, it was a big revision, but there is greater uncertainty on the GDP data, and that is reflected in the fact that we have a fan going backwards.
Secondly, as Jon was saying earlier, that relates to 2021, so, if you like, the nominal evidence that we are seeing today—let’s take inflation, for instance—is of course a reflection of what I have called “the true state of the economy”. I mean, that is a product of the economy. What the ONS are telling us, therefore, is a sort of revision to what we understand to be that true state in the past, not the true state itself. It helps us in a way—Jon made this point earlier—because we have been telling a story about the fact that we think the economy has been more resilient than we expected it to be, and, of course, the revision helps with that story.
I think there are also some points, which I know are quite specific, about how public sector activity is measured in the UK, and that there is a difference. In this country, the health sector’s activity is measured by counting procedures, as it were, but when covid broke out, the problem was that the procedures that got counted stopped happening. Obviously the health sector was doing a huge amount of stuff, but that wasn’t getting captured easily. I think the ONS have gone back and looked at that again and revised their view of what actually went on.
Q958 Chair: But in terms of your decision making?
Andrew Bailey: Well, as Jon was saying earlier, we will obviously look at it very carefully, don’t get me wrong, but the nominal data that we see today, two years after those revisions, will of course reflect what has actually happened in the economy, not how the ONS measured it at the time, if you like.
Sir Jon Cunliffe: I think the interesting question is, had we known at the end of 2021 that the economy had actually come out of the covid period much more strongly than the official data was saying, would we have taken different decisions? Over the period that followed, we started to take our own decisions based on what we could see in the economy through surveys, and increasingly, as I said, wrote more demand in than you might otherwise have done.
Q959 Chair: Do you wish you had known that at the time?
Sir Jon Cunliffe: Well, yes, but on the other hand, I have huge sympathy for a statistics agency trying to measure output in an economy that has been shut down 2 or 3 times over a pandemic with very different economic activities. That goes back to some of the points we were making about how you forecast and measure through those periods that are outside your historical experience.
Q960 Chair: Are there any other points that any of you want to land before we come to an end of the session? Dr Dhingra?
Dr Dhingra: I had a quick point about the revisions, which is that a large part of the 2021 revisions also relates to not just the services but what happened to the consumption of intermediate inputs. That is something that is really critical in the cost of living crisis because we are buying a lot from outside. What happens with the 2022 numbers? It is not very clear which way that would go, so that is something to be kept in mind.
I just want to say one thing: of course not knowing precisely what is going on in the economy muddies the waters. I have written a lot about this, and said it in speeches as well, but we need a really good data infrastructure. If there is one lesson we are going to get out of this pandemic and the cost of living crisis, it really is that we need to have a much better data infrastructure.
Andrew Bailey: If you don’t mind, I would just like to finish by echoing what you have very kindly said and put on record my thanks to Jon for his enormous service to this country.
Q961 Chair: That was going to be my concluding statement! But Jon, I do want to wish you well for everything that you do. This is your final appearance here as deputy governor, so thank you for all your public service.
Sir Jon Cunliffe: Thank you very much.