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Treasury Committee 

Oral evidence: Bank of England Monetary Policy Reports, HC 211

Monday 20 February 2024

Ordered by the House of Commons to be published on 24 February 2024.

Watch the meeting

Members present: Harriett Baldwin (Chair); Mr John Baron; Dr Thérèse Coffey; Dame Angela Eagle; Stephen Hammond; Drew Hendry; Danny Kruger; Keir Mather; Anne Marie Morris.

Questions 1060 - 1142


I: Andrew Bailey, Governor, Bank of England, Dr Ben Broadbent, Deputy Governor, Monetary Policy, Bank of England, Dr Swati Dhingra, External Member, Monetary Policy Committee, and Megan Greene, External Member, Monetary Policy Committee.


Examination of witnesses

Witnesses: Andrew Bailey, Dr Ben Broadbent, Dr Swati Dhingra and Megan Greene.

Q1060  Chair: Welcome to this Treasury Committee evidence session on the latest monetary policy report from the Bank of Englands Monetary Policy Committee. Can I please invite our witnesses to introduce themselves, starting with yourself, Governor?

Andrew Bailey: I am Andrew Bailey, Governor of the Bank of England.

Dr Broadbent: I am Ben Broadbent, deputy governor.

Megan Greene: I am Megan Greene, external member of the MPC.

Dr Dhingra: I am Swati Dhingra, external member of the MPC.

Q1061  Chair: Governor, last year and the year before, the Monetary Policy Committee raised interest rates in total 14 times, I think, in order to bring down inflation from these intolerably high levels that we were experiencing. Clearly, by the second half of last year that had tipped the UK economy into recession. The forecast that you published in your latest report seems to indicate that inflation, all other things being equal, will revert to target some time this year, as I understand it.

I wondered whether you could summarise for the Committee and the public at large, given that inflation is back down at 4% and forecast to be 2% and the economy is in recession, what it would take for the Monetary Policy Committee to reduce the headline level of interest rates now. What are the indicators that you would want to see, Governor, before you did that?

Andrew Bailey: You are right to say that our latest forecast suggests that inflation will go back to target, we think probably in the springtime this year. It will not stay there, we think, because there are some peculiarly large, particularly negative energy effects that will not be permanent. We are predicting a bit of a pick-up towards the end of this year, but nothing on the scale of what we saw, as you were referring to, in the past. Since our objective is to sustain inflation at target, we are looking beyond that temporary period where we think we will be down at target. We want to get it down and keep it down, as it were.

You are right that the economy appears to have had a period of recession in the last two quarters of last year. Monetary policy has been restrictive. We have said this a number of times. I should say that it is also against a backdrop of very weak growth on the supply side of the economy, which we will no doubt come back to. Monetary policy has been intentionally restrictive and inflation has come down very rapidly. A lot of that is to do with the unwinding of the global inflation shocks, but monetary policy has played its part and we have always intended that to be so.

I will come on to the specific points that you raised, but can I just make one point, which is very important here and has not had coverage? All of this is happening in a context of the economy being at full employment. We have had this period of rapid disinflation. We have had, yes, restrictive monetary policy, but, on all the measures we use, the economy appears to be at full employment. That is a very good story. It is very good news. We do not want unemployment rising rapidly. It has happened in the past when we have had to do these sorts of actions. That is against a lot of talk about what we think is going to be a very small recession. We think that the economy is already showing distinct signs of an upturn. We can come back to that.

What are we looking for on the permanent front? There are three things that we really look for, and they are all to do with this question about persistence. Looking through these energy effects, we look particularly at services prices, because that has a very big domestic content of inflation in it, and so tends to, in a sense, look beyond these more temporary energy-type effects. We are looking at pay and quantities in the labour market. That comes back to the point I just made about the fact that the piece of good news is that the economy is at full employment.

I will finish by saying this. It is a very tight situation and a narrow path that we are walking because of it. That means that we have to be very alert to these things. We very clearly changed the framing of the decision in the February report from the question of how restrictive policy has to be to how long it has to remain restrictive for. At the press conference, that is, How long before we can cut interest rates based on the path we see? I am looking for a more sustained progress on those three things, which are the more persistent elements.

We have seen encouraging signs on them. Service inflation is still above 6%. There are some signs of it coming down now. There are some signs that pay is now adjusting down towards the lower headline inflation, which is what I would expect to see. The quantity side of the labour market remains tight. There is no question about that, but it is the progress of those three things. We do not need inflation to come back to target before we cut interest rates. I must be very clear on that. That is not necessary. We will be looking for sustained progress on those things to reach that judgment about how long this period of restrictive policy needs to be, but we have very clearly signalled this change.

Q1062  Chair: Thank you, Governor, for the introductory outlook. Dr Broadbent, can I refer to the evidence that we are publishing alongside this session, where you have summarised some of your points? You echo the points about services prices, pay and labour market data. What worries the Committee is that there has been such a lack of clarity about labour market data. There have been a lot of questions about labour market data. I wondered whether you would like to comment on how timely the information on the labour market is that the Bank is able to get, compared to perhaps the lagged data that you would get from the ONS on the state of the labour market? Are there any particular indicators that you look to, drilling down into those indicators around service prices, pay and the labour market?

Dr Broadbent: Starting with the labour market, on the quantity side we have quite a lot of information from surveys of businesses, say, about employment trends. Some of thosefor example, our own decision maker panel surveyare also forward-looking. As far as the numbers employed are concerned, we think we have reasonably good real-time indicators.

Where we have less, inevitably, is, if you like, on the composition of non-employment. Critical for us are indicators related to the tightness of the labour market, the leading one of which might be unemployment or some variant thereof, such as the ratio of vacancies to unemployment, for example. If you want to know whether someone who is not working is either inactive, which means they are not working and not looking for work, or unemployed, which means they are not working but are looking for work, the only way you can really get that is by asking households. The only source of that information, ultimately, is the labour force survey from the ONS.

It is always somewhat uncertain. There is no piece of economic data that is absolutely precise, because you are relying on samples, but at the moment it is more imprecise than usual because of the decline in the response rate to the LFS.

Q1063  Chair: Governor, I note that last week, when you gave evidence to the Lords Committee, you specifically mentioned some of the Banks modelling in this area. You have a number of models that estimate wage equations, none of which, frankly, has performed well. Does that worry you?

Andrew Bailey: It is one reason why we have asked Ben Bernanke to do the review he has done. It is a good example. We have used a chart in a number of the reports, and I have used it in the press conferences, which shows what we call a swathe, which is, in a sense, the projections of pay produced by, I think, three sets of models we have. We also overlay that with what the committee has actually judged—I emphasise the word “judged”—to be the path of pay, drawing on a lot of other information, including from our regional agents, for instance.

For some time now, the path that we have set has been above—that is, pay is rising more strongly—what all three of the models would suggest. A lot of that reflects the unusual nature of the shocks that we have been going through. That underlies why I was so keen that we did this review and had Ben Bernanke come in and do this. It raises the question for us as a committee of how we reach those judgments. Are there better tools out there that we could lay our hands on? Are we getting the right data? How are we processing the data? Therefore, it was my view that we should learn from these experiences. That is the background to it.

Q1064  Chair: You mentioned Dr Bernankes review. We were expecting that we would have had it by now and that we would be taking evidence from him shortly. I wondered if you could update us on the timetable of his review.

Andrew Bailey: Sorry if we gave that impression. I expect that it will be produced in mid-spring. I know that he is writing very hard. He is working hard on it at the moment. I would expect that it will be coming out somewhere in the middle of the spring. If there is any change to that, we will obviously let you know, but that is my current expectation.

Q1065  Chair: Has he shared any of his initial findings with you? You say that he is writing it at the moment.

Andrew Bailey: He is busy writing it at the moment. He spent time with us back in the autumn. We have had quite a few conversations, and very useful conversations, but he is hard at work writing at the moment.

Q1066  Chair: Has he shared any of these findings with you that you are using to inform decision making?

Andrew Bailey: We are not currently using his findings. We are giving him the time to put his thoughts together and give us his thoughts. That is the best thing to do in that sense.

Q1067  Chair: Have you seen his initial thoughts, Governor?

Andrew Bailey: We have discussed his initial thoughts, yes, because he spent time with us. He observed the whole November round of the MPC and we had quite a few conversations during that round about it. We have certainly had conversations with him.

Q1068  Chair: When is mid-spring?

Andrew Bailey: I do not want to be pinned down exactly because, as I say, he has the pen, as it were.

Q1069  Dame Angela Eagle: Spring is early this year. It is happening now.

Andrew Bailey: Spring is early. It has been a very mild winter, which is another part of the story. I would say some time probably in April, I would think. He has to finish his writing, and I want to give him the time that he needs to do it.

Chair: We have heard April. That is on the record now, Governor.

Andrew Bailey: If it changes, I will let you know. That is quite clear.

Q1070  Chair: Dr Dhingra, I did not ask you about the same indicators because you have made it very clear that you think monetary policy is currently too tight. I will ask Megan what it would take for her to change her vote at the next meeting, on 21 March. Which indicators would force you to rethink the level of interest rates in this country?

Megan Greene: Like many others, I am looking at indicators of persistence. I just changed my vote, as you will all know. That is because we have learned something about persistence since late last year in the subsequent data outturn. The surprises on the labour market side with wages since November at least were significant. When you are looking at services inflation, if you strip out the impact of energyso just look at different metrics of core servicesthey are all trending down, save one, which is just flatlining. That is removing all the energy-intensive sectors. It is also the most exclusive definition of core services inflation.

We have learned enough for me to change my vote to a hold, but there are still risks in terms of wages. We know from our agent survey that there is an expectation that wage growth will be around 5.4% this year. That is a bit higher than we are forecasting, so that presents some upside risk.

On the services inflation side, we know from the agent survey that fewer firms are going to be able to pass through price increases from higher wages, but there is a risk there too. It turns out that more consumer services firms report that they will be able to pass through wage increases into higher prices. That represents some upside risk on services inflation.

I would need to see a further continuation of the trends that we have already seen. The data has been encouraging since late last year, but I would need to see further evidence before I was willing to change my vote.

Q1071  Chair: Dr Dhingra, what are they all missing? You want to see looser monetary policy already. What are they all missing?

Dr Dhingra: I am going to focus on where the evidence really swayed me to come to a decision to cut rates. The first thing is that we are on downward trajectory in terms of consumer price inflation. This is not a new phenomenon; this has been happening now for a few months. If we look at more forward-looking indicators, such as producer price inflation, which tends to lead consumer price inflation by about six to eight months—somewhere in that ballpark—even that is showing that there is more to come in terms of disinflation, including in non-energy services. That is fundamentally important for where price inflation is headed towards.

I combine that with really seeing that, despite that disinflation at play and the fact that there has been some real wage recovery, we are still seeing consumption very weak and very different from some of the other advanced economies, where there has been a bounce back from the pre-pandemic levels. We are not seeing that here.

Q1072  Chair: You think that even after Januarys retail sales.

Dr Dhingra: Yes, even after Januarys retail sales, unfortunately. It is about 2% lower, I would say2.1% if you want to be very precise about retail sales. On consumption, it is about 1.8%. That suggests to me that the downside risks at this point are substantial. Therefore, if we keep monetary policy tight for longer, that would weigh even further on that sort of real activity.

Q1073  Chair: Governor, you saw Andy Haldanes remarks yesterday about being concerned that the Bank will be seen as having been too late to start tightening and then, potentially, too late to start easing. What are your reactions to that speech?

Andrew Bailey: There was a lot of emphasis, again, on this point about the recession and not as much emphasis on the point I made earlier about the fact that there is also a strong story, particularly on the labour market and actually also on household incomes. Last year, real household income grew by 1.8%. That is real household income, so there is a strong story.

Swati is absolutely right on consumption. We have seen quite a strong labour market. We have seen quite a strong household real income. It has not really come through to consumption. Swati is absolutely right on that point. What will happen this year will be interesting on that front.

I would emphasise, on this point about the recession, that we have a very precise definition of a recession in this country. It is two successive quarters of negative GDP growth. The two successive quarters—that is, Q3 and Q4 last yearI think cumulatively add up to minus 0.5% on GDP. If you look at recessions going back to the 1970s, this is the weakest by a long way. The range, I think, for those two quarter numbers for all the previous recessions was something like 2.5% to 22% in terms of negative GDP, so minus 0.5% is a very weak recession.

Q1074  Chair: How does the UK economy grow if you have risks of inflation even when you are in recession?

Andrew Bailey: There are two ways that the UK grows. The first is by restoring price stability. That is a condition for stable growth and we are well on our way to doing that, but we have to get, as I said earlier on, to the point where it is sustainable.

The second thing—this is part of the narrow path we are having to walk hereis that we have weak supplyside growth in this country and we have had for some time. Clearly, to get faster growth, we need to see stronger growth on the supply side.

Q1075  Chair: We have had large net inward migration. Is that not the supply side?

Andrew Bailey: There is also an important part of the story on the supply side that comes through from investment and productivity growth. I would emphasise that. Sustained stable prices and sustained inflation around targets is a condition for having stronger supply-side growth. That, again, is a condition, but those are the things we need.

Q1076  Stephen Hammond: Good morning. I am going to follow on from the Chairs theme in a number of questions. Can I first pick something up? In your opening remarks, Governor, when talking about the fact that inflation was going to meet the target in the second quarter but then rise again, you talked about large energy effects. Can you say why that was not clear to you in November? It has been there as an effect for a while.

Andrew Bailey: It has got much bigger. It is a really good question. If you take the period between the November report, at the beginning of November, and the February report, at the beginning of February, the oil price fell by 13%. Gas priceswe look at these across the globe as wellfell by 36%. That is a very big change in energy prices. They have moved again since, by the way. In the period since we published the February report, the oil price is up about 9% and the gas price is down about 18%. We have had these very big moves. I would particularly highlight that move in energy prices in that period.

It was, I have to say, something of a surprise. I remember that we discussed at the last hearing the threat from the terrible events going on in the middle east. If you look back in history to the 1970s, which we have talked about a lot, you tended to see an increase in the oil price, particularly in this context, and we have not seen that. We have also had a second successive very mild winter in Europe now, and in North America this time also. That explains a lot of it.

I think that the Ofgem numbers are coming out imminently for the next reset, but you can estimate it pretty much now because we are through the observation period. Our staff are telling us that we could see the household energy price components of inflation having a negative annual rate of 25%, maybe. That is a big change. It will not last. In a sense, because it is a percentage change you would not expect it to last, but that is what is going on. That is a big contributor to the change we have seen in that period.

Q1077  Stephen Hammond: To be clear, in the November report you talked about target inflation being hit in the first quarter 2026. You are now forecasting that to be a bit higher, at 2.3% or 2.4%, I think. Is that some uncertainty about pricing, or is it lower-than-implied market rates that you are concerned about? I guess that there are two questions: first, am I right on that and, secondly, how inflationary do you regard that movement, perhaps, in terms of lower market rates, to be?

Andrew Bailey: Sorry. I should have emphasised at the beginning of the last answer that our forecasts are conditional. They are not unconditional. They are conditional on energy prices, as you said; I have talked about energy prices. They are also conditional on the market interest rate curve. The market interest rate curve between November and February, again, moved, on average, by about 1% down. It has actually corrected some of that subsequently. It is about 0.45% back up again now.

The consequence of all that was that we moved from a situation where we had inflation coming back to target about a year in, to one where it does not quite get back to target during the period that we look at. If you contrast that with the variant we published, which is the so-called constant rate forecast, where we do not change rates, that had forecast inflation coming below target and heading further down below target, so you can deduce what happens.

Q1078  Stephen Hammond: If you kept rates at a constant rate, you would hit the inflation target sometime in quarter 3 of 2025.

Andrew Bailey: Yes, but you would also have inflation heading well below target going forwards.

Q1079  Stephen Hammond: In your opening remarks, you quite rightly said that we need to get this balance right. The balance, therefore, is surely two things. One is about what the market implied rate is. One is what you are saying. Also, what is the impact of that rate for growth? Do you not think that the likely way the market and others are going to read it is that, actually, rates need to come down so that we do not hit a bigger problem with recession?

Andrew Bailey: The market is essentially embodying in the curve that we will reduce interest rates during the course of this year. The timing of when they think we are going to make the first change has moved around a bit. Sometimes it is June. Sometimes it is August. They think we are going to cut rates during the rest of this year. We do not endorse the market curve. We are not making a prediction of when or by how much, but I think you can tell from that profile of the forecast and, as you rightly said, comparing it with the constant rate forecast, that it is not unreasonable for the market to think that.

Q1080  Stephen Hammond: It is not unreasonable for the market to think that. Indeed, Andy Haldanes remarks made that point, as did the NIESR, which basically said in its report earlier this month that a little bit more forward guidance may have helped keep the UK out of technical recession. Had you given some forward guidance that you are closer to thinking in terms of where market rates might be than to where the Bank rate might be, do you think that that might have kept us out of recession?

Andrew Bailey: I do not agree with that. I was interested in the national institutes overall summary of monetary policy. At the end of its commentary, it said, “Given the geopolitical uncertainties, there should be no rush to cut interest rates quickly in 2024. Slow and steady will win the day”. Let us go back to this point about the recession. We would have had to be able to predict this recession quite a way in advance of it actually happening, given the lags in monetary policy.

Q1081  Chair: It was your forecast though, was it not?

Andrew Bailey: If you go back a year or more, we were forecasting a recession, but that was a different context. Remember, that was a context in which energy prices were very high. There were real concerns that we were going to run out of energy last winter. Of course, that turned around as well because we did not. We had a mild winter, energy prices came down a lot and we moved on from that forecast of recession. Just to emphasise, that is the point about these being conditional forecasts in that sense.

Q1082  Stephen Hammond: Sure. Governor, you are right exactly about what the NIESR said, but it also said, did it not, that the Bank of England says that it will follow evidence and take a decision when the time is right, whereas the Fed says that it thinks rate cuts are likely during a given period. I guess the point I am making, or trying to ask you about, is that, if your guidance had been similar to the Feds, might there have been less concern about the recession? I will come to Dr Broadbent in a moment, because he is shaking his head very vigorously at the moment, but I am interested in the Governors view.

Andrew Bailey: No central bank is currently predicting when it is going to make a rate cut.

Q1083  Stephen Hammond: They are predicting rate cuts.

Andrew Bailey: Some are and some are not.

Q1084  Stephen Hammond: Jay Powell has.

Andrew Bailey: The Federal Reserve publishes what it calls dot plots, which show the forward predictions, but they change the dot plots. As Chair Powell has said many times, the dot plots change. The European Central Bank has been very clear. It said in its most recent statement that it is too soon to talk about interest rate cuts. I will just emphasise that, on this whole question about forward guidance, as I was saying to the Chairs questions, we have changed what I would call our commentary to be very clear that the question now is, “For how long do we have to maintain this stance of policy beforeand that means before we start to cut, in my view. We have been very clear that that is the framing, but I do not think that any central bank that I know of is currently saying, “By the way, we will start the cuts in”—fill the month in.

Q1085  Stephen Hammond: I guess, Dr Broadbent, you are shaking your head because you are confirming the view you wrote about two years ago, where you were deeply sceptical about giving guidance.

Dr Broadbent: The risk is always that people latch on to a particular date without reading the additional clause that is always there, including from the Fed, the ECB or anybody else, which is not, “We will do this at such and such a date, but, “If such and such happens, it is likely, by such and such a date, we may move accordingly.” It is always conditional. To my mind, one risk of that is that people forget the “if” clause and just say, “They are going to cut in March,” or, “They are going to cut in May” or whenever it is. No one gives an unconditional commitment to the future path of interest rates.

We have said, “Here are the things we are looking at. If those move in a certain way, taken together, yes, it is likely that we can reduce the restrictiveness as policy.” I do not see those two things as very different. I am reminded of a very useful shorthand phrase the Government adopted about the lifting of restrictions during the pandemic: it is data, not dates. That is what we are looking at, and the other central banks are no different.

As for the effects of that, anything that a central bank might say about the future path of rates that might in turn have an effect on the economy is embodied in the path of market expectations of rates. If you look at the sterling curve, it fell during the course of the second half of last year by no less than the market curve of the Fed. Those monetary conditions eased, and they eased, just as they had here, in direct response not to statements by central bankers but to the economic data. We got larger declines in inflation than people were expecting here and in the US, and indeed in Europe. Those are the things that drove down forward interest rates, whatever the statements from central banks.

It is a good thing to see markets behaving in that way and reacting to the data. What we can do most usefully is say to people, “Here are the series we are interested in. Here are the things”—like we have been doing—“that might tell us about the persistence of inflation. Then you hope that markets pick up on that and respond to news in those series accordingly. I think that that has happened everywhere, regardless of any small differences.

If I might, I will say something else, now I have the floor, about “recession. I wanted to come back to something Andrew said a moment ago. I find this technical definition unhelpful, frankly. If you go back to the decade before the financial crisis, a period of very good economic growth, trend supply growth in the UK was, we think, close to 3% a year. It was more than 0.7% per quarter. Zero is a long way from that, and you need quite a big departure from trend to get zero growth. We now think trend supply growth is less than one. Indeed, productivity has fallen over the last year. In that environment, whether or not you happen to be technically plus 0.1 or minus 0.1 is a tiny difference. It is much easier, as it were, just with the normal volatility of the data, to get those numbers.

If you look at how other countries define recession, in the United States, for example, there is a separate body, the NBER, that says whether there has been a recession. One thing, by the way, is that it waits quite a few months before saying there was one. The data here can be revised. I remember well coming on to this committee. I think it was early days when I was on the committee, and there was a lot of excitement about the possibility of a triple-dip recession. It turns out that we did not even have two dips, because the numbers got revised.

It also looks at a much wider range of indicators. It does not just look at output growth. It looks at employment

Q1086  Stephen Hammond: Effectively, you are saying that we need to look at series, rather than one-off data. That is accepted in economics.

Dr Broadbent: The risk of this technical thing is that there is not some sudden, discrete, enormous difference that happens when you go from plus 0.1 to minus 0.1.

Q1087  Stephen Hammond: Does that reflect the view that you are expecting the possibility of revisions and/or that you expect this to be very mild?

Dr Broadbent: Indeed. As Andrew said, employment has still been growing.

Q1088  Stephen Hammond: I know that the Chair is going to cut me off in a moment, but I want to ask Megan Greene and Dr Dhingra one question. We have mentioned dot plots. Do you think that it would be helpful if members of the MPC were to set out forward dot plots, like the Fed does, that highlight your decision-making process on how rates should go in the future?

Megan Greene: The markets probably do not understand the dot plots exactly as they are intended. There is a challenge in how the dot plot is used for communication, because it represents the median and the markets take that as the Feds forecast. That is not what it is at all. That said, I have my own dot plot for the UK. I think we all have some version of our own dot plots. They are useful for forcing you to be internally consistent about where you think things are heading. They make you think about the medium term, which is appropriate, given the lags in monetary policy.

Also, in addition to communication issues, they are often viewed as a commitment, and they are not a commitment, as Ben was saying. There are always conditions that are put around them. They are problematic for that reason.

Dr Dhingra: I share the concerns regarding communication, particularly because we do not have the consensus view that the other banks have. There is a serious risk of not understanding which way the economy is headed. That being said, it forces us to think about the medium term rather than focus just on the immediate policy decision. That would be a useful feature of it.

Q1089  Dr Coffey: Recognising that getting forecasts precisely right is nigh on impossible, what is acceptable leeway, in your view?

Andrew Bailey: I do not think that there is a statistical answer to that, I am afraid, because, again, they are conditional forecasts. It depends upon how the conditions move. We are in and have been in a period where the conditions have been much more volatile. Energy prices are a very good example of this. They have been much more volatile in recent times than they would normally be. The error margins on any conditional forecast are that much larger as a result.

If I could pick up on what Swati was just saying, one question that we have asked Ben Bernanke to look at in this context is how we present forecasts and how we use them. We use the forecast as what we call a best collective judgment but, quite clearly, as you can tell from things we say, members can take different views on that. It is important that those views are transparent.

The question is whether there are better ways of conveying the range of views than we have at the moment. At the moment, we use the so-called fan chart to do some of that, but there is a very open question here, which I think we will come to in the light of Ben Bernankes report. For instance, if we were to use scenarios morein other words, present scenarios around a forecastwould that help? Would it help with your question as well? Given the inevitable uncertainty around this exercise, we need to be able to convey more of the range of possible outcomes that we can have.

Q1090  Dr Coffey: You have seen some massive swings. I guess the criticism is that, because you got it so wrong two and a half years ago, you are now overcompensating the other way, which can lead to a strangling of aspects of the economy. I guess it is that wide variation that is concerning, when you also consider the impact that that has on pay demands and other decisions that Government and businesses have to make on the basis of your forecasts, which then tend to lose credibility. That is the fear factor: that you just do not know where you are heading, coming back to the point, because you have got it so wrong in recent history.

Andrew Bailey: Can I, I am afraid, come back to a point we have discussed quite a few times? We have been living in a world of very big global shocks. Covid and Ukraine are the obvious ones.

Q1091  Dr Coffey: Does that mean that the core Bank model is itself poorly suited?

Andrew Bailey: It does not predict wars, for instance, or global pandemics. There is not a model out there that will predict wars and global pandemics. We have to use the tools we have to respond in the best way to our assessment of the impact of those shocks and how they are going to wear through the system, as it were, and that is what we do. One big question that we are keen to hear Ben Bernankes views on is whether there are tools that we can adopt or whether we can use tools differently to help with that. I am afraid that there is not a model out there that will predict wars or pandemics.

Q1092  Dr Coffey: I understand aspects of that. However, coming back to you in particular, Governor, although I would also be interested to hear from Dr Broadbent and others, there are concerns about pay. It is understandable that we cannot, let us say, have an economy that continues simply to see double-digit pay rises, but you can anticipate why trade unions, employers and others will want to consider what the prospects of future inflation are in that determination. For example, do you think that it was the wrong thing for the Government to do to raise the living wage by so much?

Andrew Bailey: No, because that is a Government policy that is done with good reason in terms of low pay, so I am not going to comment on that. The questions we have to address in the context of that policy are twofold. One is what the impact of that policy is. It is not just the impact on those who are directly affected by it, but also what the impact is, because obviously it has an effect in terms of moving pay up. It compresses gaps between those who are affected by it and those who are above it. I think we all go around the country a lot, and I get a lot of commentary on it when I go around the country.

The second point—Ben referred to it earlier—is a question I always ask firms when they talk about this to me: to what extent do you think you are going to be able to pass it on into prices? That is a key second leg of that question. I was on a visit last week actually, but over recent months firms have been becoming more hesitant about their ability to pass on. I am certainly detecting that in the commentary.

You made a point on pay generally. The way that it is working through at the moment, and what I observe and am looking to see more of, is that, as headline inflation comes down and people adapt their expectations of future inflation to that fall in headline inflation, which we are seeing in the surveys of inflation expectations, that will feed through into pay bargaining. That is what I would expect to see. We are starting to see that happening. The question, as we have all said, in terms of what we are looking at going forwards, is how much and how quickly we are going to see that happen. That is the question, I think.

Q1093  Dr Coffey: Thinking about the variety of judgments that have to be made and considered, the internal members of the MPC seem to vote en bloc. Would it be better to remove them and just have the one vote from the internal members of the MPC and then get the externality? I am not surprised that people will agree with their boss when they are in a meeting deciding interest rates.

Andrew Bailey: They are pretty independently minded people, I can tell you.

Q1094  Dr Coffey: You have all voted the same way for quite a long time.

Andrew Bailey: That is not true, actually.

Dr Broadbent: That is not quite true. That is not true.

Q1095  Dr Coffey: That is according to the analysis by Treasury Select Committee staff.

Dr Broadbent: No, it is not quite true.

Andrew Bailey: In the last two years, I think about 25% of the meetings have had a split vote amongst the executive members. I can tell you that that is, I think, a larger proportion than you see in other central banks around the world who reveal their votes, so it is not quite true.

Probably one of the most significant votes we have had recently was last September, when we decided to pause the increases. That was quite a critical moment and Jon Cunliffe dissented on that vote. He was an internal member. He dissented on that vote, and that is fine. I very strongly encourage the members of the MPC to express their views, because reasonable people can disagree on these things. We are about deliberating and then reaching decisions.

Q1096  Dr Coffey: What is the outcome that you want to get to in the future in balancing your judgments? Of course you cannot predict wars and other things, but the other main drivers of inflation certainly should be within your modelling.

Andrew Bailey: We have all said that we are now focused on the more domestic things that we think will be the determinants of the extent to which there is persistent inflationso service inflation, pay and quantities in the labour market. As colleagues were saying, we are beginning to see the signs that those are going in the right direction. We need to see more evidence of that. Certainly, speaking for myself, that is what will shape my voting going forwards.

Q1097  Mr Baron: Good morning. Governor, can I press you a little bit on the risks of monetary policy being overtight and on the implication this has for the economy and people generally? We all know in this room that these are very important decisions. They are affecting peoples livelihoods, the cost of living crisis and all the rest of it. A lot of people are having to tighten their belts at the moment, and businesses accordingly.

I would put it to you, following on from your earlier comments, that although you cannot predict these things precisely, we have at the moment an economy with very pedestrian growth that is bordering recession. We have interest rates at 5.25%. Your favourite measure, the CPI, is trending downwards—you have made that very clear—and should hit target by the end of this year, if not before. You have an easing in tightness in the labour market evident. You have a deceleration in the retail goods prices that you believe has further to go. Why are you not cutting rates now? Why are you not looking forward, and not back, and realising that a lot of the indicators that you and the MPC have created in the past are flashing red when it comes to cutting interest rates?

Andrew Bailey: Can I reset the point you made about where CPI is going to? The projection we produced suggests that it will go to target, we think, in the spring of this year, but it will not stay there. In the projection we have, by the end of the year it is around 2.75%. That is because these temporary effects wear off. It is not back at target at the end of the year on that projection. Clearly, it is in a much better place than it was, but our job is to have it sustainably at target. That is why we are looking very carefully at the indicators we have emphasised.

The question, as Ben, I think, put it, is how long we need to keep policy restrictive for us to be confident that it is not just going to settle at 2.75% and that it is on the sustainable path to 2%. That is the judgment that we have to make. We are not there yet.

Q1098  Mr Baron: I take that point. You see a tick up in CPI. You have made it clear that you do not think it is going to be very pronounced, but you still see a tick up. I accept that. To counter that, I would suggest to you that the full effects of the interest rate rises so far have not been felt by the economy. I think that your own report said that only about two thirds of the peak domestic impact of higher interest rates on the level of GDP has now come through.

I suggest to you mortgage increases as a good example of that. We know that, when the interest rate rises started, around three quarters of mortgages were fixed rate. On average, over the next three years, despite interest rates falling, we think, and inflation falling, you are still going to see a 39% increase in payments on average, your stability report suggested. These indicators are suggesting that there are counterbalancing forces to this modest tick up in CPI that you need to focus on, are they not?

Andrew Bailey: We focus a lotand I can tell you we spend a lot of time during the round that we do to determine the decisionon this question about what we call the monetary transmission mechanism, or the passthrough, as you say. It is useful to illustrate that with the round we have just had. If you go back to November, our staff told us that they thought about 50% of the pass-through had occurred. As you said a minute ago, by this round, the February round, they had revised that view to about 70%, so just a little bit above two thirds, as you said.

There are two reasons why that happened. First, there was some passage of time, but, secondly, more importantly, the interest rate curve had come down, as we were saying earlier. That means that the total pass-through will be less than we thought it would be, because mortgage rates, for instance, have come down. Therefore, given what has already come through, it is a greater proportion of the total. That is why we have got to 70%. We factor that in. That is something that we spend a lot of time considering and take into consideration. We factor these things in. It is not something we ignore at all.

Q1099  Mr Baron: Can I press you on the issue of the modelling? Following on from Thérèses pointwe raised this with you when we came to see you in the Bank of England, for example, and had that evidence session—there is a concern out there that the MPC has been behind the curve. It was behind the curve on the way up. Of course, no model can predict external shocks, but it does not get away from the fact that, as one small example, just before the war in Ukraine, mortgage interest rates were still around 0.5%. Inflation was rising and had hit 6% before the war. In other words, I put it to you that you were behind the curve then. That is now history. What is important is looking forward.

I am suggesting likewise that there is a real risk here that you are behind the curve again on the way down. I will quote something back at you if you do not mind, Andrew. You were in front of the House of Lords. Reference was briefly made to models. You have clearly said, “We have a number of models, and some of them, frankly, are delivering outputs that we do not have much confidence in. You then go on and say, The tools have not served us particularly well.

Accepting that, in all humilityand I commend you for thisshould you not be erring on the side of caution when it comes over-tightening and starting to cut rates now, when all the indicators, or most of them, are pointing in that direction?

Andrew Bailey: My response to that is that I think we have moved on quite decisively on the stance we are taking and how we are communicating it. This is the point I made earlier. I said that we have moved from the question of how restrictive policy needs to be to how long it needs to be restricted for. That was very clear; it was a very clear moving towards anticipating the point when we will be lowering interest rates.

If you do not mind me saying so, I remember back in this hearing last May, that you suggested to meand I did not disagree with you that muchthat you thought inflation would get stuck at 4%. I think that I said at the time that I could see why you were making that point, because at that time we were very worried about persistence. We have moved on. Those concerns have eased somewhat. I think that both of usI take this from what you are sayingprobably recognise that.

We are still at a point where we have to see the convincing evidence that we are going to come sustainably back to 2%, because we still have services inflation at over 6%. We have quite a wide dispersion of the components of inflation at the moment, from that figure I was giving for household energy, which might be heading down to minus 25%, to services at over 6%. Given that the minus 25% will not persist, it is those persistent elements that we need to see more progress on. That is the judgment that we have to make.

Megan Greene: Can I add something here as someone who grew up in the US in the 1980s? Given the uncertainty that the Governor has referenced, there is also a risk that you end up easing too quickly and then have to reverse track and hike even more in the end, therefore leaning on growth even more. To my mind, that is the worst scenario, and so I think it is worth highlighting that risk, given the uncertainty. That is why I, in particular, am looking for more signs that persistence is less embedded than we had initially feared before thinking about cutting.

Q1100  Mr Baron: Yes, but I would suggest that recent history would suggest that, if you look at the rate increases at the end of 2021, the Bank of England was catching up. Inflation got higher than it should have done because there was a process of catching up.

What I am suggesting to the panel this morning is that we have an admission that the modelling is not what it should be. We know that forecasting and its usefulness is under scrutiny. We have lead indicators suggesting that the economy is stillhow can I put it? We have lead indicators suggesting that inflation is coming down and will continue to do so, and still the full lag of past interest rate rises is not being felt, let alone being felt in the mortgage market. Given all that, where inflation is now and where interest rates are now, why not cut? You cannot always get it right.

Coming back to your point, Megan, if there was a tick up, you can judge that situation at the time, but I suggest to you that the risks are on the downside when it comes to inflation, and the Bank is not responding. Businesses are suffering out there. People are suffering out there because interest rates are too high. Despite this slight tick up in energy that you are forecasting for CPI, the lead indicators are suggesting that inflation is coming down; it is coming down fast. Why is the Bank not responding more?

Andrew Bailey: Can I go back to a point I made early on? As I said, this is a good part of the story, but we have to manage through it. You say that all the lead indicators are coming down, and we actually are still operating, as I said, in what we think is pretty much full employment. We have a tight labour market and it remains tight. I do not want to see that change particularly, in the sense that nobody wants to create unemployment, but we are having to manage this disinflation process in that context, which is fine. We will do that, but it means that we have to be very alert to those domestic indicators, because those are the things that are going to determine the persistence of inflation.

Q1101  Mr Baron: Your own report has suggested that there is evidence of easing in the tightness in the labour market. There are other indicators. One that has not been mentioned is quantitative tightening. The Committee is concerned about this being a bit of a leap in the dark. There is no doubt about it: money growth remains well below historical averages. I know that the Bank has not always attached a lot of importance to money supply figures. I think that there are two paragraphs on money supply in the latest report, which is more than there has been in the past. I would suggest that there is a correlation between money supply and inflation, but even those figures are coming down.

Let me just finish with this question—sorry, take on quantitative tightening if you want.

Andrew Bailey: Can I make a point on that that I made to the House of Lords last week? It is a chart that we have in the monetary policy reports. One thing that I find useful is to look at the stock of household M4 to nominal income. It is now back to its pre-covid trend. The question is what happens next. I agree with you. That is the point, but what we have seen so far has essentially taken it back to its pre-covid trend.

Q1102  Mr Baron: Do Dr Broadbent and Dr Dhingra want to say anything about this?

Dr Broadbent: Do you mean on money specifically?

Mr Baron: Yes, on the risk of interest rates being overly restrictive.

Dr Broadbent: Clearly there is a risk. There is also a risk that they are not sufficiently restrictive. There are two of us who voted for still higher interest rates. I do not agree that all the evidence is one direction. In my experienceI have been doing this quite a while nowthat is never the case. It is never the case that every lead indicator points in the same direction.

Q1103  Mr Baron: No, but a good number of them, if not the majority, are.

Dr Broadbent: Yes, indeed. Clearly, we have made good progress. I should point out that a lot of that good progress, by the way, is precisely the unwinding of the pandemic effects. You referred to 6% inflation. That was caused by these huge rises in core goods prices and tradeables prices after the pandemic. It is not just the war. The pandemic caused inflation.

Mr Baron: No, but my point was that, actually

Dr Broadbent: Can I finish the answer? There was a view at the time among all central banks that that would prove “transitory”. Although it has taken longer, that has proven to be the case. Most of the disinflation we have hadin fact, all of it over the last yearhas been in tradeable prices, on energy and tradeable goods. Those things are pretty volatile. They have been enormously volatile over the last three years. Even if they do not prove transitory in the space of a year, those movements tend to last less longer in general than the lag we need before a policy decision has its peak impact on inflation.

As we have all said, we are looking at these more persistent things. I agree that there has been some encouraging news there as well, but I do not think that it is true to say that it is all clearly pointing in the same direction. We have services inflation over 6%. We have wage growth of over 6%. Both of those are probably almost twice the rates we think are consistent with a stable inflation target. We have to take a view on the balance of these risks. Of course, it is absolutely true to say that there is a risk that there is over-tightening. There is also a risk of too little. Every round we meet, we try to balance those two things.

Dr Dhingra: There are risks on both sides, to some degree. In my view, I do not want to err on the side of over-tightening, for the reason that that could come with a hard landing, which we have, up until now, fortunately, avoided. Also, that then risks damaging supply capacity in a more long-lasting way.

Q1104  Mr Baron: This is my final question. We have raised this issue with the MPC before as a Committee, and it is groupthink. I know that the voting split was more pronounced on this last occasion. In a way that is welcome, particularly for those who worry about the risk of over-tightening. Are you going to address this issue of groupthink? There is a concern that it exists, not just with the Bank of England but perhaps with other central banks as well.

Let me give you one example. In probably the most passionate economic debate we have had for a generation, on whether to leave the EUBrexit, basicallythose who have declared on the MPC were all on the side of remain. There is no evidence of anybody actually saying that Brexit was a good idea. That is one small example of where I think there may be an element of groupthink. Do you think that is unfair?

Andrew Bailey: I have been very clear for the last eight years that, as a public official, I do not take a position on Brexit per se. That is the right thing to do.

Mr Baron: I was not looking at you when I was saying that.

Andrew Bailey: I am afraid that you cannot pin a view on me, because I have been very clear that I do not, as a public official, take a view on Brexit. It is very important that we are objective in assessing the economic consequences and the economic issues around Brexit. We have provided our assessment where it is appropriate. I have to say I feel very fervently that that is the right way to do it. I do not think that the right way to do it is to say, “Let us have a few of everything on the committee.” We are public officials in that sense.

Q1105  Mr Baron: You are doing all you can to ensure that, putting Brexit to one side, you address this central concern about groupthink. You probably would not have brought in Ben Bernanke if you had not. That is one of his briefs.

Andrew Bailey: As you said, you can tell from the voting on the MPC that there is not much evidence of groupthink in terms of the outcomes of the MPC.

There is an interesting question—I agree with you—which, again, the House of Lords has raised with me in the past, which is whether there is a deeper groupthink in the economics world. By the way, Ben Bernanke is one of the most eminent economists in the world, so I do not think that we can have any question around his approach to that. It is always important that we take on board new thinking in the discipline. It is always important that the discipline does not become, in a sense, single-minded in terms of how it approaches these questions. We all have a part to play in that. You are right on that point.

Q1106  Keir Mather: Thank you all for coming today. I have found the tenor of this conversation a little interesting, in the sense that we have had a few mentions of the 1970s today. It feels like you guys have been in the unenviable position of unpicking a Barber-esque dash for growth over the last two years and are now getting criticised for not unpicking it quickly enough, but that is maybe a discussion for another time. In relation to fiscal events coming down the track this year, Governor, is the Bank anticipating tax cuts, either in the spring Budget or in pre-election fiscal events this year?

Andrew Bailey: We never anticipate any fiscal policy. We wait for fiscal policy to be announced. The report we have just produced and the forecast we have just published take on board the autumn statement. It does not make any anticipatory judgment as to what might be to come.

Q1107  Keir Mather: If you are in a situation, though, where there are still lots of fluctuations in energy prices, the outlook for inflation is unclear over the course of the year and you know that tax cuts have the potential to be coming down the track, based on reporting that we have seen, is there any view as to whether tax cuts, in the form in which they are reported now, could be inflationary?

Andrew Bailey: I would be a bit cautious about that. First of all, we will have to see what they are. Let me give you the example of the autumn statement, because we covered this in the report. Our assessment of the measures that the Chancellor introduced in the autumn statement—by the way, we talk to the OBR a lot and we use some of its methodology—is that they have a positive effect on GDP, but they do not have much effect on inflation. The reason for that is that we think there is also a supply-side benefit from them, particularly due to the welfare and labour market measures bringing more people into the labour force.

At the end of the day, our judgment and what our staff proposed to us was that the inflation impact of the autumn statement was very small. It was not really registering much, because we have to take on board not only the demand consequences but also the supply consequences, because that is what matters for us.

Q1108  Keir Mather: In relation to decision making on the MPC, in an election year you not only do not know the content of the spring statement; you also do not know when the general election will be.

Andrew Bailey: I was hoping somebody would tell us.

Keir Mather: If anybody else wants to enlighten me, I would be more than happy. It will be this year.

Mr Baron: It will be before next February.

Q1109  Keir Mather: Do you feel as though members of the MPC might be hedging in their decision not to reduce interest rates because, effectively because of the spring Budget, tax cuts are a known unknown?

Andrew Bailey: No. That is very definitely not part of our thought process. We condition on what we know. We do not anticipate fiscal policy statements. We do not anticipate elections. The election will happen when it happens, from our perspective. That is not part of the decision-making process.

Q1110  Keir Mather: Are there any circumstances in which you feel like the Bank would have to maintain the rate in order to offset a potential inflationary impact of tax cuts

Andrew Bailey: I honestly cannot prejudge what the Budget is going to contain. Once the Budget is announced, the Chancellor has made his statement, and we have talked to the OBR and got its analysis, we will factor it in. The May monetary policy report will have all that in it.

Q1111  Keir Mather: In an FT article last week, sources close to the Chancellor suggested that Treasury officials were considering reducing projected departmental spending rises to around 0.75% a year due to tax cuts. We have spent a lot of time in recent weeks on the Committee talking about macroprudential risk, but does the Bank take a view on or have an assessment of what the impact of real-terms departmental spending cuts could be on factors such as labour market participation and business investment, and their concurrent impact on growth?

Andrew Bailey: Once it is all announced, we use the OBR’s costing and impact methodology for that. We do not have our own. The OBR will have gone through that in great detail. They will have assessed all these very detailed measures. Our staff talk to the OBR a lot, but we essentially take that as our basis.

Q1112  Keir Mather: To what extent do your projections match the OBR’s assessment of the impact of the autumn statement?

Andrew Bailey: They match very closely.

Q1113  Keir Mather: I would also just like to pick up on something that the Chancellor said in May last year about him being comfortable with the notion of a recession in order to get inflation down to target. What is the perspective of members on the MPC as to whether a recession is a necessary evil when it comes to getting inflation down in the long term?

Andrew Bailey: We are not seeking a recession. I have to be very clear on that point. We do not target growth in that sense. We are targeting inflation. We provide forecasts. They give our assessment as to what the growth profile is going to be, consistent with that path of inflation. As the Chair said earlier, going back about 15 months or so, there was a point in time when we were forecasting a recession because of the situation particularly in the energy markets.

Our position is very clear. We are definitely not seeking a recession. We forecast, but we are not targeting growth in that sense.

Q1114  Dr Coffey: Can I just clarify a couple of things? You say you do not forecast fiscal events but, in a different piece of evidence or analysis that has been shared by Select Committee staff, you are assuming that the fuel duty escalator will kick back in, and therefore that will drive inflation. Help me understand that. Certainly, it is well over a decade since we have had the fuel duty escalator. So why don’t you learn, in terms of how much judgment gets put in your hands?

By the way, Dr Broadbent has voted consistently with the Governor, according to the analysis, at every single meeting he has ever been at when discussing interest rates.

Dr Broadbent: I am just trying to think how this is connected with fuel duty.

Q1115  Dr Coffey: You talk about the judgment you bring and then you say, “We wait until something is announced”. You do not use that, but you are saying, “We cannot do that because it will drive inflation”.

Dr Broadbent: We base the forecast on announced fiscal policy. Announced fiscal policy says, “Yes, we plan to raise the fuel duty”.

There is an alternative universe in which we forecast fiscal policy. I can think of a particular example when the forecast undoubtedly would have been much better in an objective sense; it would have been a less conditional view of the future. In February 2021, when lockdown had happened but the furlough scheme had not yet been extended, we were faced with a situation where the announced fiscal policy was to end the furlough scheme, but pretty much everyone knew it would be extended.

If we said, “As a practice, let us forecast fiscal policy, there would be occasions when the forecasts would be better. As it happens, the fuel duty escalator has a small effect. It would not have much effect in the medium term, which is more relevant for our decisions. It would not be that material for monetary policy. My own view is that that would be a bad state of affairs. If we came before this Committee, you would be asking us all the time what our forecasts for fiscal policy were.

It is much better to take a more neutral approach and base the forecast on announced policy. To take your example, it may well turn out to be the case that this is not imposed for another year, but it is the case that that is the announced intention and the plan. Even if, more generally, there were occasions when we would end up with a better forecast, it would not be the right thing constitutionally for us to start forecasting fiscal policy.

Andrew Bailey: It is a really good question, but the awkwardness is that stated Government policy is at odds with practice. There is a tension there.

Q1116  Dr Coffey: I have one other question. Mr Mather has suggested that trying to grow the economy is what has led to the huge inflation. It has been external factors, which you have already said to the Committee. Just tell me a little bit more in terms of your predictions. There is going to be an election this year. Tell me where you think the biggest change in tax cuts or increases in spending could make a difference to the growth of the economy.

Andrew Bailey: I passed over the Barber boom comment because, with all respect, I was not sure it is central to the analysis.

Q1117  Anne Marie Morris: I want to ask about unemployment, as opposed to people who are not seeking work. Dr Broadbent, earlier on you suggested that this is going to be a very difficult issue and that, currently, it is hard to distinguish between the two. It is relatively easy to work out who is employed—you can talk to their employer—but it is very hard if somebody is not seeking work. The ONS has said it is going to look again at a different way of dealing with this.

Given that challenge, which seems to be intractable right now, and given how important wage growth is—your prediction as to whether wage growth is going to go up or down impacts what your decision on rates will be come next time—how robust is your view that employment will rise 4% to 5% by the end of the period? I am just trying to get a steer as to how, given all those uncertainties and given how important wage growth is, you are going to address that when you start sorting out the next rate rise or fall.

Dr Broadbent: There is no doubt that it is an additional uncertainty. As you say, in time we will have an improved survey of the labour market and households, the transformed LFS, but that is some months away yet. The ONS has said it is not planning to launch it until September. You are also right to say it is more of an issue for us than the uncertainties about the level of employment, because we have these other indicators.

I have a couple of points about wage growth specifically. One is regarding the tightness of the labour market. We have a few things. Andrew referred to the suite of models. We have a graph of those. The one that has performed best over the last couple of years—I am not sure it is in that suite—is one that has vacancies in it. Formally, it uses the ratio of vacancies to unemployment. The rate of unemployment still matters for that.

We look at vacancies and a few other indicators of labour market tightness. There is a question in a couple of business surveys about the availability of labour. Our own agents ask their contacts that question. Those have proved quite useful as well. I do not think we have no other indicators to tell us about that pressure, even if I agree that there is a little more uncertainty than usual. If you look at the forecast for unemployment, there is a big fat fan around them.

I have one final point about wage growth. It is true that slack in the labour market does matter a lot. It is one central means or channel through which monetary policy works, for example. The bigger influence over the last two years has simply been spot inflation from all the global shocks that we have been talking about. Those drove the vast majority of the upward moves in inflation. They have driven just about all the moves down from the peak over the last year. Perhaps for our short-run expectations for households, those have been the biggest influence.

Our expectation that wage growth will continue to fall is mainly the result of the declines in spot inflation that we are getting from drops in core goods inflation and energy inflation. That is not to deny that we still have uncertainty about the rest of the determinants, including slack in the labour market, but for my part I feel reasonably confident that wage growth will edge down a little further over the next few months. I do not deny that it makes life a little harder when we are not exactly sure what the current rate of unemployment is.

Q1118  Anne Marie Morris: Ms Greene, how do you feel about this, particularly given your insights as to what goes on in the US? Clearly, the trend post covid here has been very different to the US and indeed in a number of other markets. In the US, we saw a number of women coming into the market who had not been in work before. We saw people with disabilities coming into the market. They are another group that is very hard to identify.

Do you share Dr Broadbent’s concern, but not over-concern, or are you a bit more concerned about the robustness of the labour market, given how important it is to understand where the labour market and wage growth are going? Do you feel, when you are making your decision, that you are in a position to make it with all the evidence you need? Do you have enough evidence?

Megan Greene: Uncertainty around the data certainly produces uncertainty for us, but I will highlight that, although we do not have fantastic data on inactivity versus unemployment, there is a lot of data on participation in the UK that is not provided elsewhere. People are asked in surveys here, “Why aren’t you in the labour market?” They can say, “It is due to long-term sickness.” The UK is a real frontrunner on this. You cannot replicate that data anywhere else. That does provide some details on the participation rate, the labour supply and why people might not be coming back into the labour market. That has given us a bit of a steer.

In terms of how this all impinges on wage growth and therefore my monetary policy stance, I would reiterate the point that Ben has made. The biggest driver of wage growth over the past couple of years has been inflation expectations. Following a huge energy shock like the one that the UK has seen, inflation expectations tend to be backward-looking. That amplifies the second-round effects because everybody is more sensitive to the original shock.

Given that that is the case, if inflation is coming down, inflation expectations should continue to come down along with it. That should take some upward pressure off wage growth. I feel reasonably sure that we are headed in the right direction. We are still well above levels that are target-consistent, but at least the trend is in the right direction.

Q1119  Anne Marie Morris: Dr Dhingra, are you in agreement that wages are coming down and that you have enough evidence, given all of the uncertainties we have talked about?

Dr Dhingra: The drop in vacancies that we have seen is much higher than anywhere in the euro area or the US. I take a slightly different view on inactivity, though. The issue that you bring up is really important, but much more from a productivity point of view than a wage growth point of view.

Particularly if you look at the finer data up to the point it is available to us, the inactivity numbers show that there was a lot of heterogeneity—there were regions that saw an increase in inactivity and those that did not. It was typically lower-income people who were seeing more of a rise in inactivity. At that point, wages were not really rising more in those areas where you were seeing higher inactivity. I do not necessarily think of it as wage-inflationary. These issues tend to arise in more depressed areas. Instead, I see it more as a really serious productivity issue.

Q1120  Danny Kruger: I want to continue the conversation about global shocks and the effect on our inflation forecast. I echo the comments made by colleagues here and Andy Haldane and others. In my view, we risk choking off our recovery if we rates do not come down soon. The great unknowable remains the effect of global events.

I want to probe a bit more deeply into why, although there is this obvious concern about cutting rates too soon, you are not more worried about what is going on in the Red Sea. Some 30% of the world’s container ships are effectively having to take the long way around. I recognise that, as a result, we have not seen what might have been expected in terms of falls in energy prices and wider goods prices, but should we not be more concerned, particularly if that conflict persists, as it seems likely to do?

If you are going to answer by saying that the energy futures market seems robust and is not predicting falls, what do you say to the suggestion that that is because of distortions caused by algorithmic traders exaggerating the trends that we are seeing at the moment? We have had this warm winter. The bots are basically reinforcing current practice rather than being a proper indicator of future prices. Is there not a risk that we are betting on these distorting algorithmic trades that are going on, rather than really estimating what might happen in the energy market in the future?

Andrew Bailey: We talk a lot to those who are directly in the energy market. There are various parts to that question. I will try to split it out.

On energy itself, you are right. As I observed earlier, we have had a second warm winter in succession. As Dame Angela was saying, we are well through the winter and spring is beginning to appear. At the moment, storage levels for gas remain at high levels. It looks like we are going to be coming out of another winter and heading into the next one with higher storage levels.

The point that has been put to me a number of times by producers on that front is that there is a window that we have to get through before the world’s supply of liquefied natural gas and the infrastructure to supply it expands. People have talked to me about that running through to next year and possibly 2026. That is the period where there is a concern about the world gas market, but we have just been dealt an enormous benefit by the weather. That does not get us all the way there, but that is the analysis you get from people. I do not think they are running bots. They are in the energy supply business.

On the Red Sea, I agree with you. That is why we have an explicit risk in the projection to reflect this. There is a temporary upside risk to inflation in our forecast to reflect disruption from the Red Sea. I think it is the case that the Suez canal is used more for goods than for oil. The redirection is more of a goods thing than an oil thing particularly. It is certainly the case—our staff take a lot of time over this and we do factor it in—that shipping costs have gone up. It is nothing like the rate they went up during the covid recovery period. We do factor that in.

I agree with you. I heard you say in a hearing the other day that I was rather sanguine about this. I am not sanguine. The fact is that we have had some things go our way collectively, it seems to me, but this thing is a terrible risk. These events are terrible events.

I talk to a lot of people in the oil supply business. What I take from what they say is that, particularly in the middle east, there is a desire to keep the oil price stable. There is a point beyond which, as they always say to me in rather serious tones, that will not be possible, but we have not reached that point. We have to be concerned. You are right: that risk exists.

Megan Greene: Can I just add to that briefly? I spend a lot of time talking to global supply chain logistics companies, including one in Billericay recently on an agency visit.

Andrew Bailey: It is part of the globe actually.

Megan Greene: It seems that there is a general consensus. As you know, we are making policy based on what will happen further out in the medium term. There is a general consensus that the capacity of global containers is due to increase significantly over the next couple of years. While a lot of ships are having to go the long way around, which represents a supply constraint, a lot of supply will be coming online. Over the medium term, that might offset some of that.

Dr Broadbent: I am sorry to jump in again, but I have one additional point. We think about what the extra costs are, and people tell us about the cost of going around the Cape. In the background—this will be the dominant effect, absent some other huge shock—you have had these big falls, or certainly declines, over the last 18 months in the underlying wholesale prices of tradeable goods. This is something that Swati referred to earlier.

In connection with the unwinding of the pandemic effects, probably starting in the summer of 2022, manufacturers’ output prices started to fall globally. That decrease was not huge, but they have declined even here. In China, for example, the numbers are quite negative. Those declines are much bigger than the additional costs of shipping. That is why, at least in our central forecast, we have core goods inflation—it peaked at something like 8% and has now come down—going almost to zero next spring.

Q1121  Danny Kruger: That is helpful, thank you. It is good to hear that kind of analysis is going on. I do worry when I hear analysis that is simply based on what the futures market seems to be saying.

Just quickly on that point, maybe I will ask you this. Just going back to my anxiety about algorithms, as I understand it 70% of daily crude trades are basically automated. Are you not concerned about the herd mentality of the machine exaggerating existing trends? Is that all okay?

Andrew Bailey: If you do not mind me saying, I am not sure why it would be more concerning in this market than any other. Algorithmic trading is clearly growing. The use of AI is growing. Putting our regulatory and financial stability hat on, we do follow this quite closely. Is it more pronounced in this area?

Q1122  Danny Kruger: My concern is that we are betting a lot on it. We have had the Chancellor in here before giving his predictions. In fact, when we were being told that inflation was transitory a couple of years ago, it was because of the sense that the futures and energy markets were bullish.

We are betting on technology that is designed to pursue quite short-term information and to exaggerate the trends that currently exist. You have just been explaining, much more intelligibly, why we should have confidence that energy prices are going to continue to fall. I worry a bit about the degree to which we are reliant on automation in this market.

Dr Dhingra: Can I come in on this point? When I joined the MPC, this was one of the key debates that was happening because energy futures curves were being used to condition our forecasts. There was a great sense of caution about that. We made the judgment not to rely solely on the futures market curves, not simply because of the algorithmic trading that you are referring to, but because these also happen to be very thin markets. You are really basing your judgment on something which does not have much data to back it up.

Q1123  Danny Kruger: They have also been very volatile recently.

Can I move on? This is to the panel in general. There seems to be a difference of opinion between different central bankers about the inflationary consequences of a persistent or worsening situation in the middle east. The ECB has suggested that a persistent conflict would have a dampening effect on confidence globally, whereas the more obvious direct effect would be an increase in oil prices. Is there a collective view on which side we should lean in our predictions?

Dr Broadbent: In over-technical language, this is a trade-off-inducing shock. To varying degrees, it would probably have both those effects.

What one could say—at least this is my feeling, and it is what we have tried to do over the last couple of years, specifically in response to the enormous hit to energy prices as a result of the war—is that we are less focused on those direct impacts compared to the second-round effects than we would be, if I can put it that way.

Even then there is a trade-off because, as we discussed earlier, domestic inflation of wages and services prices might respond to higher headline inflation, but equally it will reduce people’s real incomes, which might depress spending. I do not know whether I would be willing to give a definitive answer about which of those would win out, but my answer is that both would happen and we could only judge the situation in real time as to what the appropriate policy response should be.

Indeed, both those things happened during 2022. In the event, we tightened policy pretty aggressively because we had the pandemic effects plus the war and there were a lot of second-round effects. In principle, both those things are true. That is one of the difficulties in deciding how you respond to these things.

Megan Greene: That is fair. If this were prolonged or were to expand beyond tradeable goods into energy, we would be in trade-off territory. It would probably put some upward pressure on prices and it would probably put some downward pressure on demand.

Dr Dhingra: I would add that the supply-side pressure on prices is probably going to be the first thing that hits. That is why we probably need to be cautious about inflation spiking up again.

Q1124  Danny Kruger: This is perhaps for you, Governor. You are suggesting that there will be a slight rise again towards the end of the year. If there are persistent inflationary effects from the global situation, does it automatically follow that rates would have to rise again, given the degree to which, as we have all been acknowledging, inflation has largely been a consequence of global shocks?

I appreciate that we have to have a domestic response to it, but the extent to which monetary policy will substantially affect inflation in the UK is questionable, given the degree to which it is caused by import prices. Would you expect to see rates go up again if we see inflation rising?

Andrew Bailey: Ben set it out very well. I was smiling initially because I thought we were back into transitory territory, in the sense of judging the shocks in terms of their effects and their duration.

Ben also made a very important point about this trade-off question. Supply shocks have the characteristic of inducing trade-offs between inflation and activity. We would have to judge that again and present it as such. We also have to bear in mind—this is the problem we have had with the shocks that we have been through—that these shocks might have been transitory and viewed in isolation, but they came together and so therefore you had a much longer period of shock.

I raise that because, although we are out of that period, there is something of what I might call a shadow still from it in terms of how people respond to it. We would have to judge that as well in terms of how people react.

Dr Broadbent: I just want to pick up on one small thing, if I may. It is quite a big thing, actually. You are absolutely right: in the short run, I cannot think of another period in history where we have seen bigger evidence of this. We are a very open economy. Huge moves in import prices inevitably have a big effect on our rate of inflation. Over the medium term, however, as we like to say, in the absence of those shocks—you cannot see them coming—monetary policy and the credibility of policy are the determinants of inflation.

This Committee has previously been interested in comparisons with the 1970s. Those are quite instructive for this reason. The combined hits of the pandemic and the war, at least while they lasted, say from the spring of early 2021 through to the autumn of 2022, were about twice as big as the hit in the 1970s from the rise in energy prices. It was absolutely enormous. Yet two years after that in the 1970s, inflation was still 16% and interest rates were in double digits. This is nothing like that. The reason fundamentally that this is different from the 1970s, to my mind, is precisely because we have a proper nominal anchor, an inflation target, and a body that is charged with setting policy to meet it.

That comparison is quite instructive. It is not the case that policy cannot control inflation, even if, over short periods of time—this has been far longer than we would have liked, obviously—global shocks or any other shocks can move you around. Ultimately, it is monetary policy and the credibility of monetary policy that determines the rate of inflation in the medium term. That is the striking difference between now and the 1970s.

Chair: We are publishing the nine-page letter that you have sent us, Governor, on things like algorithmic trading today. That will be out there for everyone to look at.

Andrew Bailey: I will not pretend it is the last word on the subject.

Chair: No, but it is full of interesting nuggets.

Q1125  Dame Angela Eagle: I was interested in what Dr Broadbent just said. Essentially, you were arguing that we have a better institutional structure and that it is not only to do with the inflation anchor. I felt you were also at least hinting that the independent structure of the Monetary Policy Committee has helped to strengthen that, and yet there are increasing noises off, particularly from various ex-Cabinet Ministers, complaining and grumbling about the Bank’s performance.

The Member for North East Somerset has even pronounced that that independence is part of the problem. To what extent is it helpful to undermine the institutional structures that have been in place since the late 1990s, Governor, in this particular instance?

Andrew Bailey: You would expect me to be a very strong advocate and defender of the independence of the central bank in this respect, and I am. Ben set it out very well. One of the lessons from this whole period is the effect of, as Ben said, not just the nominal anchor but the fact the operation of the nominal anchor is in the hands of an independent central bank with, if you do not mind me saying so, accountability to Parliament, like today. That is an important part of the whole process.

Q1126  Dame Angela Eagle: That is about the transparency of your decision-making process, which we are examining today.

Andrew Bailey: In a way, it almost goes without saying. Yes, I am a very firm believer in this. I understand that not everybody accepts that case. I am afraid I do not agree with the contrary opinion.

Q1127  Dame Angela Eagle: I have something to say about groupthink, which has come up as well. You have a binary choice, or I suppose you can put interest rates down, keep them where they are or put them up. There are only ever three choices that any Monetary Policy Committee can make. Therefore, it is perhaps not surprising that there is bunching around the small number of choices that you have. That would be accurate, would it not?

Andrew Bailey: Yes, although we have a greater array of different votes on our committee than some of the central banks that publish that information. It is important that we reach a conclusion, but, given that, it is important, reasonable and sensible that we set out the differences of view.

As I say, nine people can come to reasonably different views on this thing. That is why we are here, really. That is why there are nine of us. We operate as an independent body, but each of us is here independently. We should reflect those views.

Q1128  Dame Angela Eagle: The recent growth figures have demonstrated that there has been even less per capita growth. There have been small declines in that over the last seven quarters. Does that worry you? It looks like whatever growth we are getting—it is terribly modest, as we have been talking about—seems to be based on immigration, which the Government are currently trying to restrict.

Andrew Bailey: Going back to where I started, in a situation where we have—this is a good thing—strong employment and a strong labour market but weak activity in the economy, it is the case that per capita GDP is not going to look very good. You are right: it does not. You are also right that the latest numbers that the ONS has published take on board its latest revisions to the population numbers.

This comes back to the point I made earlier. We need to have stable prices; we need to have inflation sustainably at target. The question then becomes one of boosting the capacity of the supply side through investment and productivity growth. We have had weak productivity growth for some time now. The UK is not unusual. This is a pattern that you see in other countries as well. That is the thing that we need to address. Of course, it is better to do that against a background of stable, low inflation.

Q1129  Dame Angela Eagle: I was going to come on to ask why productivity has fallen despite full expensing and a range of other policies that have been announced to try to address that. To what extent have the political uncertainty and shenanigans that we have had in the last few years added to the problems with productivity growth or the lack of it?

Andrew Bailey: That is not the whole story. As I say, it is a pattern that you see in other countries. The UK is not unusual in this respect. The Bank took no view on Brexit per se, but we have published our economic analysis of it. We did say that we thought there would be a productivity effect in the short run. In the longer run, trade repositions itself, as it were, but that takes a while to happen. There is an effect there, but it is not a peculiarly UK thing. We have seen it go on in other countries.

There are puzzles. There are puzzles as to why some of the technological change we have seen globally has not come through into stronger productivity. The next big question that we face is about AI in this respect. I would caution—many years ago, I was an economic historian—that the evidence from past major technological changes suggests that it does take time for that to feed through into productivity. There is some good work on that subject.

Dr Broadbent: I have one more thing to add, purely as a short-term comment. You are absolutely right: it looks like productivity has fallen over the past year. Some of that—it is difficult to tell how much—is more cyclical than structural. If you go on agency visits, there are companies you meet that are doing what we would call, as economists, labour hoarding. They have seen material declines in activity but not yet laid people off.

I went to see a big housebuilder in the autumn. It had seen a fall of 30%. It is by far the most cyclical part of the economy and the most sensitive to interest rates. It had not laid anybody off. The reason for that is because it thinks, “Things will turn around, and it is costly to rehire people, so let us just keep them employed”. We think the economy is probably now growing in the first quarter and we have it growing again in the second. It is possible that you get that upturn but without any increase in employment.

There is no doubt that, as the Governor said, productivity growth has been significantly weaker than it was before the financial crisis. Even to the extent that it is structural, I suspect that energy price impacts and import price rises had some effect on productivity itself. US performance has been much better, but the eurozone has been closer to what the UK has experienced. As I say, some of the weakness over the last year is labour hoarding and, to that extent, temporary.

Q1130  Dame Angela Eagle: Could we learn lessons from the experience in the United States in terms of turning productivity around?

Dr Broadbent: They too had relatively weak productivity growth. The real differences emerged in the last couple of years. I would not want to say definitively what has caused that difference, but I suspect that the absence of a huge energy price shock was one thing. It has certainly been striking how much better productivity growth has been there than in Europe generally, not just in the UK.

Megan Greene: The US has seen a veritable boom in productivity growth over the past quarter or so. It is a bit too early to say whether that is a structural shift or just a bit of a blip. It does look a lot better than productivity growth across the rest of the developed world. If we compare investment across advanced economies, the US is pretty much the leader. The UK has been a laggard on that front for a number of years since the global financial crisis. That probably plays into it as well.

Q1131  Dame Angela Eagle: I just wanted to ask about the transmission mechanism for interest rate rises. As we have seen, the Bank rate has gone up by 5%. You estimate that about 2.1% of that has been passed through in terms of savings.

Given that we are just coming into banks’ results season—we read this morning that Barclays is doing a share buyback of £10 billion—to what extent is the interest rate transmission mechanism working? Are savers being reasonably and properly rewarded? This is something that the Committee has been focused on. With the big share buybacks and the weak savings rates, is there an issue with the transmission mechanism?

Andrew Bailey: Part of a speech I gave at Loughborough University a week ago was about this.

Dame Angela Eagle: Governor, I am sorry. I did not catch it.

Andrew Bailey: No, do not worry. There is no reason why you should be expected to read my speeches at all. That was just for reference because I am going to refer to it.

One of the points that I made in that speech is that we have seen a re-establishment of what I might call the relationship between deposit and saving rates and our official Bank rate. In a sense, the relationship had been disturbed by having the Bank rate near the lower bound, near to zero. That means the net interest margins of the major UK banks are basically where they were just before the financial crisis.

That is relevant. It is relevant to the point that you made about the news this morning. Effectively, banks have to cover their cost of capital through their earnings. Looking at the major UK banks, that is in a stable place. The relationship between the cost of capital, net interest margins and earnings is stable now. They are covering their cost of capital in that sense.

I made the point in the speech that what happens next should be governed by competition. We have had this structural adjustment back to the world where our interest rate—let us not get into the question of whether it will go up or down next—is in normal historical territory. We have seen that relationship re-establish itself in the banking system.

That is not a surprise for me. We have seen some difference between site deposit rates and term deposit rates. That is regulation, because we have incentivised banks to take term deposits because they do not run as quickly. I spent quite a bit of time in the Loughborough speech on the question of run risk, given what we saw last year. That is a change that we have seen, but that position is now stable in that sense.

I will just finish by mentioning Barclays. I do not want to comment on Barclays itself. There is a choice between doing buybacks and paying dividends. At the moment, there seems to be a greater preference for buybacks from shareholders. That is why you are seeing some of what you are seeing in announcements like the one today.

Megan Greene: Can I just add to that? From an international perspective, if you look at the pass-through to site deposits in the US, the eurozone and the UK, there is more pass-through in the UK than in the other jurisdictions, for what that is worth. From an international perspective, the UK is not massively out of line; in fact, it is looking a bit better.

Q1132  Chair: I am going to try to sum up, but I have a quickfire way of doing that in terms of questioning. We know that we are on Table Mountain. Interest rates are at 5.25%. From what we have heard today, the question is, “How long are we going to be on Table Mountain?” What came across very clearly in your evidence is that at some point we are going to come off Table Mountain with a downward move. However, you are still tightening. You are still doing quantitative tightening. How much tightening is there still to feed through from the previous interest rate hikes? That is a number that you should know.

Andrew Bailey: Can I make two points on that? First of all, on the point about previous interest rate hikes, I made the point earlier that our staff has estimated for this round that about 70% of the transmission of previous hikes has come through now. That is up from 50% back in November, for the reason I gave, which is partly the lapse of time but also because the curve has come down. The total amount of tightening is less, so therefore—

Q1133  Chair: There is still 30% of it to feed through this year and you are still doing quantitative tightening. You are still tightening.

Andrew Bailey: We are very clear that quantitative tightening is not an active monetary policy tool. The way in which it works is we set the Bank rate after taking into consideration all the information, including where the interest rate curve is. Any effect that quantitative tightening has will come through in the interest rate curve. When we set the Bank rate, we take that into account.

Q1134  Chair: We know that. You have told us that that is about 10 to 15 basis points, which is small but not zero. You are still tightening.

Andrew Bailey: Hang on.

Dr Broadbent: The point is more than that. The point is simply that the current level of Bank rate takes into account any dampening effect of that 10 to 15 basis points. We do not think there is anything overall. If you believe that quantitative tightening works only via the prices—

Q1135  Chair: We have previously had evidence from your colleagues that it is about 10 to 15 basis points.

Dr Broadbent: Yes, but we take that into account in setting the current Bank rate. We think the overall monetary conditions are appropriate, including any effects of QT. As long as you believe that those effects are transmitted via the prices of financial assets and as long as you take into account in your forecast those same prices and then base the Bank rate on that forecast, you will not be adding any unwarranted tightening.

Q1136  Chair: I hear what you say. You are all agreeing that there is still some further tightening from your previous actions that will feed through into the real economy this year, although you have also acknowledged in this session that the next move in interest rates is going to be downward, all other things being equal.

Andrew Bailey: Accepting the point that Mr Kruger made about the risk in the world, yes.

Q1137  Chair: I am going to ask you now to think about where you are as being on a seesaw. Table Mountain has been used as an analogy. You are on a seesaw. You have two risks on your seesaw. I am going to call one of them risk A, which is the risk of over-tightening, and I am going to call one of them risk B, which is the risk of labour market and wage pressure leading to sustained and persistent inflation. Out of risks A and B, which is the highest? This is a quickfire round. I just want you to say “A” or “B”.

Dr Broadbent: We made a forecast that was conditional on an interest rate curve that had cuts in it. If you look at the forecast with constant interest rates, it is very clear that it is likely that interest rates will have to be lower at some point.

Conditional on that expectation, my own belief is that in the current Bank rate, allowing for the fact that it is likely to fall in future, those risks are balanced. That is exactly why I voted the way I did. I would not weight one—

Q1138  Chair: Both A and B are significant risks.

Dr Broadbent: Yes, they are both risks. At any point in time you are trying to reach a decision that means, “I risk over-tightening just as much as I risk under-tightening”. That is where you want to be.

Q1139  Chair: Dr Dhingra, you are very clear that the risks of over-tightening, which is A, are more significant. Is that a fair summary of your view?

Dr Dhingra: Yes. The only exception would be a situation where global prices spike up again.

Q1140  Chair: Indeed, yes. Ms Greene, what is your view?

Megan Greene: I am in the same position as Ben in terms of thinking that the risks are balanced. I am more worried about the risks of underdoing it, because of what I said earlier about the experience in the 1980s and having to reverse-hike rates even more than we would have had to and dampen demand even further. That is the most pernicious scenario.

Q1141  Chair: You are for B being the bigger risk. Governor, is the bigger risk A or B?

Andrew Bailey: Like Ben, I am comfortable with a profile that has cuts in it. That is not to say when we are going to cut or indeed even how much, but I am comfortable with that profile.

I was also comfortable with one other thing, which goes back to Mr Kruger’s point. We had an upside risk on inflation that was to do with persistence. Because of the nature of that persistence, my views were being more shaped by the profile of the forecast with the risk in it than not. Now that we have moved to what I would call more of an event risk, I am happy to wait and see what happens on that front. If it crystallises, we will respond, as we were discussing earlier. That is an important difference.

I am comfortable at the moment with a profile that has cuts in it, but that is not to say when or how much.

Q1142  Chair: You acknowledge that more tightening is built into your current position on Table Mountain.

Andrew Bailey: Policy will continue to be restrictive. You are right to say that there is more transmission to come through, but all of that is factored into our forecast and into our judgments.

Chair: I wanted to conclude with a bit of a quickfire round to distil the essence of today’s session, which has been a long and very interesting one.

Dr Broadbent, I think I am right in thinking that this might be the last time we see you as you come to the end of your second term. Thank you on behalf of the Committee for your service over the years and your testimony today. Thank you to everyone else for your testimony. We look forward to seeing you again soon.