London (MNI) – The following is the text of the key passages of
Bank of England Monetary Policy Committe member David Miles’s written
annual to the Treasury Select Committee Tuesday.
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Report to Treasury Select Committee

David Miles

External monetary policy committee member

June 2011

Voting record

In the last year I have voted to maintain the size of the Bank’s
asset purchases at stg 200 billion and hold Bank Rate at 0.5%.

Output growth remained weak during the past 12 months, while
inflation rose considerably above target. This left MPC members with a
difficult choice. Tighter monetary policy could bring inflation back to
target more quickly. But it would also prolong the period of weak
economic growth. This would worsen the long-term impact of the financial
crisis. It might also mean that monetary policy changes would need to be
sharply reversed further ahead.

The remit of the MPC gives it the task of judging the appropriate
policy to bring inflation back to target after shocks have driven it off
course. I consistently voted for keeping Bank Rate unchanged. The main
reason is that the drivers of higher inflation are likely to be having a
temporary impact. The increase in VAT, higher energy prices, and higher
import prices account for more than 100% of the inflation overshoot. In
contrast, underlying domestically generated inflationary pressures
remain weak. Although there is very likely to have been a reduction in
the supply potential of the UK economy, the scale of the decline in the
level of GDP since the banking crisis suggests that there is significant
spare capacity. Wage pressures have been subdued, with settlements
running at around 2% despite a rise in household’s nearterm inflation
expectations. The MPC’s central forecast, which I believe is plausible,
is that inflation will return to close to target by the end of next
year.

Another reason for keeping Bank Rate at an exceptionally low level
is that the spreads between Bank Rate and the rates that banks charge
when lending to households and firms remains substantially higher than
before the recession. For example, the spreads between unsecured lending
rates and Bank Rate have widened, depending on the type of loan, by six
to ten percentage points. Spreads between mortgage rates and Bank Rate
have increased by about two percentage points. Put differently, some
bank lending rates are now at a level that, ahead of the crisis, would
have been consistent with Bank Rate being several percentage 2 points
above its current level of 0.5%. The monetary policy stance is not as
loose as the current level of Bank Rate might suggest.

These spreads remained wide as banks own funding costs increased
as investors re-assessed risk. Banks have also re-assessed the risks
associated with certain types of lending. They may also have attempted
to generate higher profits to repair their balance sheets. In my view,
this illustrates that an insufficient level of bank capital contributed
to the depth of the recession and continues to delay the recovery.

Over the past year I have voted to keep the size of the Banks
asset purchases constant. During the recession, asset purchases are
likely to have eased credit conditions. They also provided insurance
against the downside risks to growth and inflation from constrained
credit supply. In some respects these risks have diminished: measures of
bank and corporate leverage have fallen, and output growth has picked up
from 2009. However, risks remain. Further asset purchases may be
warranted at some point in the future.

The outlook

Both the financial and non-financial sectors are making steady
progress in reducing their leverage. However, concerns in sovereign debt
markets focusing on the sustainability of fiscal policies in some
European countries may lead to a further tightening in credit
conditions. Economic developments in the euro area are particularly
important for the UK given its importance as an export market.

In the UK, net lending to individuals and non-financial companies
has remained weak. A renewed tightening in credit conditions could
inhibit the growth of private sector demand. If so, the degree of spare
capacity in the economy would continue to push down on prices in the
medium term and CPI inflation might then fall back below the MPC’s
target.

None of this means that I am comfortable with the current high rate
of inflation. Far from it. We continue to face the problem of balancing
risks: risks that inflation above target lasts long enough to become
ingrained in expectations and affect behaviour so that it is hard to
bring down, versus risks that the recovery in output becomes weaker and
then disappears, leaving inflation pressures lower than is consistent
with the target further ahead. 3 There is a clear risk that a protracted
period of high CPI inflation could lead to higher inflation expectations
becoming entrenched. Private-sector longer-term inflation expectations
have increased according to some measures, though appear stable
according to others. There is little evidence that any rise in inflation
expectations has led to higher wage growth. Without a pick up in wage
inflation I do not think it likely that inflation being significantly
above target is sustainable. Of course wage pressures may build
significantly over the next year, though I do not believe this is the
most likely outcome. Risks of an extended period of low growthwhich
would further weaken those pressuresare also real.

Explaining monetary policy

In the eleven months since I last presented my annual report, I
have made several visits to areas outside of London, including the
Southeast & East Anglia, West Midlands, North East, Central Southern
England and the East Midlands. On these visits I have spoken to many
companies large and small – and learnt a great deal about price
pressures and about how monetary policy might affect firms in various
sectors.

To communicate my views on monetary policy more widely I have given
several interviews (to BBC Radio Sussex, Derby Telegraph, East Anglian
Daily Times, Eastern Daily Press, The Financial Times, Northern Echo,
and Stoke Sentinel).

I have also spoken at a number of schools and universities to
explain how monetary policy in the UK is being set.

I have given four on-the-record speeches, all of which focused on
the link between the financial sector and monetary policy. I also
published a Discussion Paper on the optimal level of bank capital.

–London Bureau; Tel: +44207 862 7499; email: lcommons@marketnews.com

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