Minutes Of The Monetary Policy Committee Meeting Held On 5 And 6 ...
Publication date: 19 August 2009
MINUTES OF THE
MONETARY POLICY
COMMITTEE MEETING
5 AND 6 AUGUST 2009
These are the minutes of the Monetary Policy Committee meeting held on
5 and 6 August 2009.
They are also available on the Internet
http://www.bankofengland.co.uk/publications/minutes/mpc/pdf/2009/mpc0908.pdf
The Bank of England Act 1998 gives the Bank of England operational responsibility
for setting interest rates to meet the Government’s inflation target. Operational
decisions are taken by the Bank’s Monetary Policy Committee. The Committee meets
on a regular monthly basis and minutes of its meetings are released on the
Wednesday of the second week after the meeting takes place. Accordingly, the
minutes of the Committee meeting to be held on 9 and 10 September will be published
on 23 September 2009.
MINUTES OF THE MONETARY POLICY COMMITTEE MEETING HELD
ON 5 AND 6 AUGUST 2009
1
Before turning to its immediate policy decision, and against the background of its latest
projections for output and inflation, the Committee discussed financial market developments; the
international economy; money, credit, demand and output; and costs and prices.
Financial markets
2
There had been some notable increases in asset prices during the month. Global equity prices
had increased considerably, more than reversing their falls over the previous month. The FTSE All-
Share index had risen by 13%, with particularly marked increases in the stock prices of financial
companies. Sterling investment-grade corporate bond spreads had fallen on the month, continuing the
decline evident since April. Again, there had been large movements in the spreads of securities issued
by financial sector companies.
3
Those asset price movements may have reflected a reduction in perceptions of macroeconomic
and banking sector risk. Information derived from FTSE equity options prices had suggested that
market participants viewed the risks to near-term economic activity as less negatively skewed than a
month ago. Moreover, UK banks’ credit default swap (CDS) spreads had fallen, possibly as investors
had gained reassurance from announcements during the month that banks’ earnings results had been
broadly in line with analysts’ expectations. But those CDS spreads had remained elevated relative to
pre-crisis levels.
4
Consistent with a reduced perception of banking sector vulnerability, sterling Libor rates had
fallen, and three-month Libor-OIS spreads had shrunk to levels last seen at the beginning of 2008.
Market intelligence had suggested that some of the reduction in Libor rates could also be attributed to
weak demand from banks for wholesale funding, as well as an increase in the supply of term funding.
That might partly have been a result of the increase in banks’ reserves resulting from the MPC’s asset
purchase programme.
2
5
Medium and long-dated gilt yields had increased by around 25 basis points during the course of
the month. But spreads between government bond yields and OIS rates had fallen markedly since the
beginning of the year. This was in contrast to the United States and euro area, where central banks’
purchases of government bonds had been smaller relative to the size of the outstanding stock. That
suggested that the MPC’s asset purchases had played a part in reducing gilt yields relative to where
they might otherwise have been.
6
Market expectations were for Bank Rate to remain unchanged at 0.5% for the rest of 2009, but
for an increase beyond that horizon to around 1.5% by the middle of 2010. That was around 50 basis
points higher than at the time of the July MPC meeting. The sterling effective exchange rate had
appreciated by almost 3% on the month, and by 15% since the start of the year, although it remained
some 20% below its mid-2007 level.
The international economy
7
US GDP had fallen by 0.3% in Q2, a slightly smaller reduction than many commentators had
expected. But significant revisions to the national accounts implied that the recession had been deeper
than previously estimated. Real GDP was estimated to have declined by almost 4% since the middle
of 2008.
8
More timely monthly indicators remained consistent with a gradual stabilisation in activity, both
in the United States and in other advanced economies. The US ISM manufacturing PMI for July had
risen to 48.9 from 44.8 in June, and the non-manufacturing index, despite having fallen fractionally on
the month, remained above the level it had averaged during the second quarter. Both the
manufacturing PMI and service sector business activity index for the euro area had increased in July.
And the same had been true in Japan, where the manufacturing PMI had reached its highest level since
February 2008.
9
Improvements in the activity indicators in the rest of Asia had been more striking. The four-
quarter growth rate of Chinese GDP was estimated to have increased to 7.9% in 2009 Q2 from 6.1% in
the previous quarter. Output in Korea and Singapore had rebounded strongly in the second quarter. In
the three months to June, industrial production in several Asian economies had been growing at rates
3
in excess of those seen in the years leading up to the global recession, although the level of industrial
production had remained some way below its pre-crisis high-water mark.
10
To a large extent, the strength of Asian industrial output growth probably reflected a bounceback
from the significant falls in activity that had accompanied the abrupt contraction in global trade flows
around the turn of the year. But the robust activity data may have also reflected an increase in
domestic demand in the region, supported by strong credit growth and sizable fiscal stimulus packages.
If so, that should have contributed to an unwinding of the global demand imbalances that had played a
role in the build-up to the financial crisis. But it remained to be seen how durable that unwinding
would be, since fiscal expansion and rapid credit growth could not be sustained indefinitely. There
was also a risk that rapid Asian industrial output growth, while beneficial for global activity in the near
term, could put renewed upward pressure on commodity prices and therefore global inflation.
Money, credit, demand and output
11
The aim of the MPC’s programme of asset purchases was to boost nominal spending to ensure
that it was consistent with meeting the inflation target in the medium term. One diagnostic of the
programme’s initial impact was the growth of broad money, although there was unlikely to be a
simple, straightforward mapping between asset purchases, monetary growth and nominal spending.
M4 growth, excluding the money holdings of institutions that intermediate between banks, remained
weak despite having picked up in the second quarter. On an annualised basis, this quarterly measure
of underlying broad money growth had increased to 3.7% in 2009 Q2, compared with 3.3% in the
previous quarter.
12
Part of the impact of the Bank’s asset purchases on broad money had been offset by the strength
of long-term bank debt and equity issuance in the second quarter. It was possible that institutional
investors had run down their deposits to purchase these securities. It was also possible that non-
financial companies had used the proceeds from increased issuance of capital market securities to
repay bank loans. Those factors would have had a depressing impact on broad money growth, yet both
could have positive consequences for the economic outlook. If they had led to the banks raising more
capital and companies adjusting their balance sheets, that would support bank lending and money
spending in the future.
4
13
But the rate of money growth could also have been weak as a result of the restricted supply of
bank lending. The spread of new lending rates over Bank Rate and Libor remained elevated. It was
also likely that the demand for bank lending had declined as the recession had taken hold.
14
The contrast between the historical GDP data and the more timely and forward-looking
indicators of activity, such as business surveys, had persisted this month. The ONS estimated that
GDP had fallen by 0.8% in 2009 Q2, following a 2.4% decline in the previous quarter. But it was
likely that output had stabilised in the middle of the year. Industrial production had increased by 0.5%
in June. And the CIPS/Markit manufacturing output index had increased in July to 55.1, above its
long-run average, and reaching its highest since December 2007. The services business activity index
had been above 50 in July – the level associated with expansion – for the third successive month, and
was at its highest since February 2008. The CBI Industrial Trends Survey showed a significant
improvement in confidence about future prospects.
15
These survey indicators were encouraging. But they were measures of the change in output
rather than its level, and it was not altogether surprising that output growth had begun to recover after
the precipitous fall in activity that had occurred around the turn of the year. The level of output
remained well below its previous peak. Furthermore, there was significant doubt over the extent to
which the recovery would be sustained.
16
Among other factors, the prospects for consumption would be an important influence on the
durability of the recovery. Retail sales volumes had risen by 0.8% in Q2, following a 0.3% rise in Q1
and private car registrations had picked up, partly reflecting the Government’s vehicle scrappage
scheme. But there was as yet little information on whether the weakness of household spending on
services seen around the turn of the year had persisted. Overall, it seemed likely that the pace of
contraction in consumption had moderated. There were some factors that could hold back any further
recovery in household spending. Credit supply was tight and highly indebted households might seek
to reduce their debts by increasing saving. Expectations of a higher future tax burden, given the fiscal
consolidation that would be necessary in the years ahead, and continued uncertainty about job
prospects were also likely to lead to higher levels of saving.
17
But there were factors that could support household spending. There had already been a
significant downward adjustment in the level of consumption. Compared with a year earlier, mortgage
5
rates had fallen as Bank Rate had been cut sharply. And the housing market had continued to recover.
House prices, according to the average of the Halifax and Nationwide indices, had risen by 1.2% in
July – the third consecutive monthly rise in this measure. Moreover, to date, employment had not
declined by as much as might have been expected given the falls in output.
Costs and prices
18
According to the LFS measure, the number of people employed had declined by 269,000 in the
three months to May. Surveys of employment intentions suggested that companies were expecting to
reduce the size of their workforces in the coming months, but that the rate of contraction was slowing.
The LFS measure of unemployment had risen by 281,000 in the three months to May. The more
timely claimant count measure had increased by 167,000 in the three months to June, a smaller
increase than in the previous three months, consistent with the signal from the employment intentions
surveys.
19
Pay growth had remained weak. Abstracting from the recent volatility caused by sharp
movements in bonus payments, private sector regular pay had risen by 2.4% in the three months to
May compared with a year earlier, according to the average earnings index. That compared with 2.9%
annual growth in the first quarter, and an average of 4.0% since 2000.
20
CPI inflation had fallen to 1.8% in June. Inflation was likely to be unusually volatile during the
coming months. It was likely to fall sharply during 2009 Q3 as the large increases in domestic gas and
electricity prices during 2008 dropped out of the twelve-month comparison. It was more likely than
not that inflation would temporarily fall below 1% in the autumn, requiring an open letter from the
Governor to the Chancellor of the Exchequer. But base effects from movements in petrol prices a year
earlier, and the scheduled reversal of last year’s VAT reduction would probably mean that inflation
would rise back up again around the turn of the year. Movements in commodity prices had the
potential to exacerbate that volatility.
21
The YouGov/Citigroup measure of inflation expectations twelve months ahead had fallen
fractionally in July to 1.8%. The measure of expectations of inflation five to ten years into the future
was unchanged on the month. Similarly, forward measures of inflation derived from financial market
prices had not moved significantly on the month.
6
The August GDP growth and inflation projections
22
The Committee reached its policy decision in the light of the projections to be published in the
Inflation Report on Wednesday 12 August. The factors driving the outlook for economic growth were
broadly unchanged since the Committee’s previous projections in May. Activity would be supported
in the near term by a turnaround in the stock cycle, and over the forecast period by the significant
stimulus from monetary and fiscal policy, and by the past depreciation of sterling. But there were also
factors acting to impede a recovery in spending, both in the United Kingdom and overseas. Credit
conditions were likely to remain tight. Past falls in asset prices, high levels of private and public sector
indebtedness, and concerns about job security were likely to hold back spending. And the recovery in
global demand remained susceptible to further shocks, especially if the imbalances that contributed to
the financial crisis were not rectified.
23
The Committee continued to judge that these factors were, on balance, most likely to lead to a
slow recovery in the level of economic activity. That outlook was more than usually uncertain,
reflecting the abnormal set of shocks hitting the economy and the difficulty in quantifying their effects.
The balance of risks remained weighted to the downside. But the Committee judged that the
probability of activity contracting for a further sustained period had fallen.
24
The Committee judged that a significant margin of spare capacity was likely to persist over the
forecast period. That would bear down on inflation, partly offset by the impact of sterling’s past
depreciation on consumer prices in the near term. The outlook for inflation was more than usually
uncertain, and would in the medium term depend crucially on the impact of the recession on supply
potential, the responsiveness of inflation to the emerging margin of spare capacity, and the extent to
which inflation expectations remain anchored around the target. Overall, on the assumption that Bank
Rate moved in line with market yields and that the stock of purchased assets held in the Asset Purchase
Facility (APF) reached £175 billion, the Committee judged that CPI inflation was more likely to be
below target in the medium term than above. In the projection for CPI inflation conditioned on Bank
Rate held constant at 0.5%, and a stock of purchased assets held in the APF of £175 billion, the risks
of inflation being above or below the 2% target at the two-year horizon were broadly balanced, albeit
that the path of inflation was rising.
7
The immediate policy decision
25
During the month, the Bank had met the MPC’s target for purchases of £125 billion of assets
financed by the issuance of central bank reserves. Although it remained too early to assess the full
effect of the asset purchase programme, there were some promising signs that it was having a positive
impact. The United Kingdom had seen a large reduction in the spread between government bond
yields and OIS rates by comparison with similar markets overseas. Corporate bond spreads had fallen,
gross issuance had been strong, and the rate at which the Bank had been acquiring corporate bonds had
slowed, consistent with a pickup in private investor demand.
26
By contrast, another diagnostic for assessing the initial impact of the asset purchase programme,
underlying broad money growth, had been surprisingly weak. To some extent, however, that might
have reflected the impact of institutional investors’ acquisition of banking sector assets, which should,
in time, encourage greater bank lending. It might also reflect companies using the proceeds of capital
market issuance to pay off bank debt. But this would still be consistent with the asset purchase
programme boosting nominal demand.
27
The Q2 GDP data had been weak. And last month’s downward revisions to estimates of output
around the turn of the year had made the recession appear rather deeper than at the time of the May
Inflation Report, increasing the likely degree of spare capacity in the economy. The more timely
indicators of economic activity, including business surveys, indicated that output in the United
Kingdom had probably stabilised in the middle of the year. Financial market sentiment and indicators
of business and consumer confidence had improved. While these were encouraging developments,
and indicated that the likelihood of the very worst near-term downside risks to activity had lessened,
they shed little light on the key question of how durable the recovery would prove to be in the medium
term.
28
In Inflation Report months, the Committee considered the likely future evolution of the economy
through the analysis and discussion of its quarterly projections for GDP growth and CPI inflation.
Those projections suggested that, without a greater monetary stimulus than embodied in the
combination of implied market expectations for Bank Rate and the current £125 billion scale of the
MPC’s asset purchase programme, nominal demand would likely be insufficient to prevent inflation
remaining below the 2% target, perhaps substantially, throughout the forecast period. The publication
8
of such a projection might cause market participants to re-evaluate the likely path of Bank Rate and the
market yield curve to fall. That could provide an additional stimulus to current activity, and lessen the
need for further asset purchases. But such an effect was far from guaranteed.
29
The projections indicated that an increase in asset purchases of £50 billion would probably need
to be combined with a lower path of Bank Rate than implied by market yields to balance the risks of
inflation around the 2% target in the medium term. Assuming that Bank Rate followed the path
implied by prevailing market yields, a larger increase in the scale of the asset purchase programme was
likely to be necessary to counterbalance the risk that inflation would fall short of the target.
30
There were arguments in favour of a considerable expansion of the programme at this month’s
meeting. The potential adverse consequences of adding another large monetary stimulus might be less
severe than the possible costs of acting too cautiously. Insufficiently stimulatory monetary policy
would cause inflation to remain below the target for a sustained period of time, depressing inflation
expectations, and might harm public confidence in the recovery causing it to falter. Confidence in the
efficacy of monetary policy might also be damaged, limiting policymakers’ ability to stimulate the
economy in future. In addition, if it became apparent that monetary policy had been overly expansive,
policy could be tightened by a combination of asset sales and increases in Bank Rate.
31
But there were also arguments for a more moderate expansion of the programme, given that
some of the most immediate downside risks to the economy seemed to have receded. The channels
through which large-scale asset purchases affected the economy, and the magnitude and speed of those
effects, were uncertain. The substantial injections of liquidity into the economy might result in
unwarranted increases in some asset prices that could prove costly to rectify or in inflation
expectations moving upwards. Moreover, if the asset purchases proved to be more effective than
anticipated, an early withdrawal of some of the monetary stimulus might prompt a sharp rise in market
interest rates that was unwarranted by the economic outlook.
32
There was a range of views amongst the Committee over the precise balance of risks to the
outlook for inflation and how much significance to ascribe to the various arguments about the
appropriate policy response to that outlook, although all members agreed that substantial further asset
purchases were needed over the next three months. For most members, an increase in the size of the
9
asset purchase programme of £50 billion to a total of £175 billion was warranted, while for others
there was a case for a larger stimulus.
33
The Governor invited the Committee to vote on the proposition that:
Bank Rate should be maintained at 0.5%;
The Bank of England should finance a further £50 billion of asset purchases by the creation
of central bank reserves, implying a total quantity of £175 billion of such asset purchases.
The Bank should seek to complete the additional purchases within the next three months.
Six members of the Committee (Charles Bean, Paul Tucker, Kate Barker, Spencer Dale, Paul Fisher
and Andrew Sentance) voted in favour of the proposition. Three members of the Committee (the
Governor, Tim Besley and David Miles) voted against, preferring to increase the size of the asset
purchase programme by £75 billion to a total of £200 billion.
34
Following the MPC’s decision, the Governor and Chancellor of the Exchequer exchanged letters
about the expansion of the Asset Purchase Facility.
35
The Committee agreed to spread the additional purchases of £50 billion evenly over three
months so that their completion would coincide with the preparation of the November Inflation Report
projections. Nevertheless, the scale of the asset purchase programme would continue to be reviewed
every month in the light of economic developments. The Committee noted that the increase in the
scale of its asset purchase programme required an increase in the range of maturities of government
debt that the Bank was willing to acquire to include all conventional gilts with a minimum residual
maturity of greater than three years.
36
The Committee noted that the Bank would make available to the Debt Management Office
(DMO) a significant amount of the gilts purchased via the Asset Purchase Facility for on-lending to the
market by the DMO through its normal repo market activity. The Committee was also briefed on
changes to operational procedures that would affect the level of central bank reserves, which were to
be communicated to the market later in the day.
10
37
Finally, the Governor expressed his appreciation to Tim Besley for his contribution as a member
of the Committee.
38
The following members of the Committee were present:
Mervyn King, Governor
Charles Bean, Deputy Governor responsible for monetary policy
Paul Tucker, Deputy Governor responsible for financial stability
Kate Barker
Tim Besley
Spencer Dale
Paul Fisher
David Miles
Andrew Sentance
Nicholas Macpherson was present as the Treasury representative.
