London (MNI) – The following is the text of the key passages of
Bank of England Deputy Governor Monetary Policy Charles Bean’s written
annaul to the Treasury Select Committee Tuesday.
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Report to Treasury Select Committee

Charles Bean

Deputy Governor for monetary policy

February 2011

Voting record

My previous report, in February 2010, was written just as the ONS
produced its first estimate for GDP in 2009 Q4, showing growth of just
0.1% (subsequently revised up to 0.5%), the first quarter of expansion
after six quarters of contraction. At that point, the MPC had lowered
Bank Rate to 0.5% and purchased stg 200 billion of assets financed
through the issuance of central bank reserves, moves which I had fully
supported. In the associated Inflation Report, the Committees
projection under market interest rates to which I subscribed was for
mean growth to recover to around the UKs historical average rate during
2010 and to continue thereafter at a little above that rate. CPI
inflation was projected to reach 3.4% in 2010 Q1, but then to fall back,
dipping below the target, as the downward force from persistent spare
capacity outweighed the waning influence of the pass-through from the
depreciation of sterling in 2007-8 and the restoration of the standard
rate of VAT to 17.5%.

A year ago, the strength and durability of the recovery was unclear
and considerable downside risks remained. For me, the question then was
whether further asset purchases would be needed or not, and whether
their effectiveness as a monetary tool might decline, the more purchases
we made. At that juncture, I thought it best to pause to take stock of
the strength of the recovery and to assess the impact of the monetary
actions that we had already taken.

As the year progressed, so the recovery seemed to be gaining a
firmer footing much as I expected, at least until the snow-affected fall
in activity in 2010 Q4. Offsetting that, however, I became increasingly
concerned about the potential for sovereign debt problems in several
euro-area periphery countries to lead to a new bout of financial market
turbulence, denting the recovery and depressing inflation in the medium
term.

While growth has been roughly in line with expectations, CPI
inflation has been markedly higher than I expected back in February
2010. That reflects two primary factors. First, we appear to have
significantly under-estimated the degree of pass-through from sterlings
2007-8 depreciation, incorrectly assuming that it would be broadly
similar to that seen after the exit of sterling from the ERM in 1992.
Second, commodity prices, and global prices more generally, have been
markedly higher than expected by either us or market participants,
reflecting both adverse supply factors and robust growth in emerging
economies. In addition, the downward force from spare capacity appears
to have been less than I originally judged and, of course, the further
increase in VAT to 20% has more recently resulted in an additional rise
in the price level.

From a policy perspective, what matters is inflation in the medium
term there is little we can do about inflation in the near term and
I have concurred with the consensus on the Committee that the influence
of the factors presently boosting inflation should prove temporary: the
influence of the 2007-8 depreciation of sterling should be nearly
complete by now; commodity prices are unlikely to continue rising at
such a rapid rate; and the increase in VAT is unlikely to be repeated in
2012. Accordingly, given the fragility of the recovery, I have judged it
appropriate to vote to maintain the existing stance of monetary policy
at all MPC meetings over the past year. But I have become rather more
concerned that the period of elevated inflation may persist for somewhat
longer than I originally thought, and for me the balance of risks to
inflation around the target has been shifting upwards in recent months.

The outlook

I expect growth to resume in 2011 Q1, but underlying growth across
2010 Q4/2011 Q1 together looks likely to be weak. What is presently
unclear is whether this represents a temporary soft patch of the sort
that is often seen during recoveries, or whether it represents a more
durable slowing in the rate of expansion as the joint headwinds of
fiscal consolidation and the squeeze on living standards from the
deterioration in the terms of trade hit home. That is something we
should learn more about in the coming months.

Inflation is set to remain well above the target, most probably in
the 4-5% range, for much of this year. There may be some respite from
commodity price inflation as supply conditions in agricultural markets
improve, but a reversal of last years price rises is only likely if
global growth were to slow sharply. And continued robust growth in
emerging economies may result in further upward global price pressures,
though their contribution to inflation here is likely to diminish as
2011 proceeds. I still expect inflation to drop back as we go into 2012
and this years increase in VAT drops out of the twelve-month
comparison, though a rebuilding of profit margins and some second-round
effects on pay growth may help to keep inflation a little elevated above
the target next year. But the period of substantially elevated inflation
cannot persist indefinitely unless either the external shocks are
repeated or a rise in inflation expectations leads to durably higher pay
growth and a wage-price “loop”. At this stage, that does not appear to
be happening, though I shall be watching the relevant indicators
carefully in the coming months.

Explaining monetary policy

Since my previous report in February 2010, I have given four
on-the-record speeches on monetary policy issues, together with numerous
off-the-record presentations to a variety of audiences. I made five
regional visits (to Birmingham/Coventry, Southampton, Kent,
Merseyside/Cheshire and Wales) involving various meetings and events
with local business people. I also attended a variety of events with
journalists, City economists and market participants. Finally, as Deputy
Governor for Monetary Policy, I also represent the Banks views in a
number of international settings, including the G7, G20, and the OECD.

–London Bureau; Tel: +442076341624; email: lcommons@marketnews.com

[TOPICS: MT$$$$,M$$BE$]