Feb 23, (Reuters) - Below is the text of a statement by BOE Governor Mervyn King to the Parliamentary Treasury Committee on Tuesday.
TREASURY COMMITTEE OPENING STATEMENT
'Since members of the MPC last came before this Committee, there have been some signs of a recovery in demand around the world, and also at home. But this nascent recovery is fragile. The tensions that underlay the build up of large world imbalances have not been resolved. And, at home, bank lending to the non-financial sector continues to fall. So the risks to the Committee's central view of a gradual recovery of output remain to the downside.
Some countries - especially those whose banking systems were relatively unscathed by the crisis - have seen strong growth in recent quarters. But recovery in our largest export market - the euro area - appears to have stalled. And, as I highlighted in my speech in Exeter, to maintain levels of economic activity around the world high-saving countries must expand their domestic demand while low-savings countries are reducing their net borrowing from abroad. At present, there is little evidence that this is taking place. Some countries are reducing significantly their borrowing from abroad, but, without a compensating pick up in external demand for their goods and services, these countries will continue to experience weak recoveries. The euro area is a microcosm of that broader problem.
In contrast, conditions in financial markets have continued to improve, with the prices of many risky assets rising and risk premia declining somewhat. Short-term funding markets are almost back to normal with interbank lending spreads remarkably close to their pre-crisis levels. That has fed through to some recovery in property markets, where prices have risen by around 10% since their troughs last spring. Nevertheless, markets in a range of securitised instruments have not re-opened, and are unlikely to do so without fundamental reforms to their design and transparency. And there is a considerable challenge for the banking system to refinance the funding it has obtained with support from the public sector. As the financial sector repairs its balance sheet, other sectors of the economy, especially the public sector, also need to strengthen their finances. As a result, there is likely to be a considerable drag on spending in the economy.
To offset the effects of these headwinds, the MPC decided at its February meeting to maintain the unprecedented level of monetary stimulus, by holding Bank Rate at 0.5% and maintaining the stock of assets purchased over the past year at £200 billion. The effects of the money-financed asset purchases will persist and together with the low level of Bank Rate, will continue to provide a substantial boost to money spending for some time to come. In addition, output in the economy is still benefiting from the effects of the depreciation in sterling that occurred in 2007 and 2008.
Judging how these various factors will play out is an extremely difficult challenge. In part, that is because the effects of the stock cycle, the restoration of the standard rate of VAT to 17½% and even the cold weather in January mean that data are likely to be volatile over the next few months. Last week, I wrote an open letter to the Chancellor to explain why inflation had risen to 3.5% in January - more than a percentage point away from the target. This is the third episode in which I have written such open letters. As in the previous episodes, the Committee believes that the current high level of inflation reflects temporary factors, such as the restoration of the standard rate of VAT to 17½%, higher oil prices and the effects of the exchange rate depreciation continuing to feed through. We are conscious that just four months earlier inflation was 1.1%. And the Committee believes that, although it is likely to remain high for a few months, inflation is more likely than not to fall below the 2% target in the second half of this year as the influence of spare capacity bears down on inflation.
Chairman, our economy has embarked on a process of healing. That will take time. The crisis has left us facing many serious challenges. Among them are how to reform the international financial system, how to reduce our largest peace-time fiscal deficit, and how to restructure our banking and financial system to prevent another, more serious, crisis in future. The crisis did not originate in the non-financial sectors of the economy but that is where most of the costs are falling. You don't need me to tell you that its impact is not just economic but also social and political in nature. Throughout the crisis, your Committee has led the way in putting forward proposals to leave the UK economy better placed to meet those challenges. I thank you for that, and I look forward to working with the Committee again in a new Parliament. With that, I and other members of the MPC here today stand ready to answer your questions. Keywords: BRITAIN BANK/TEXT (London Treasury Desk) COPYRIGHT Copyright Thomson Reuters 2010. All rights reserved. The copying, republication or redistribution of Reuters News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters.
TREASURY COMMITTEE OPENING STATEMENT
'Since members of the MPC last came before this Committee, there have been some signs of a recovery in demand around the world, and also at home. But this nascent recovery is fragile. The tensions that underlay the build up of large world imbalances have not been resolved. And, at home, bank lending to the non-financial sector continues to fall. So the risks to the Committee's central view of a gradual recovery of output remain to the downside.
Some countries - especially those whose banking systems were relatively unscathed by the crisis - have seen strong growth in recent quarters. But recovery in our largest export market - the euro area - appears to have stalled. And, as I highlighted in my speech in Exeter, to maintain levels of economic activity around the world high-saving countries must expand their domestic demand while low-savings countries are reducing their net borrowing from abroad. At present, there is little evidence that this is taking place. Some countries are reducing significantly their borrowing from abroad, but, without a compensating pick up in external demand for their goods and services, these countries will continue to experience weak recoveries. The euro area is a microcosm of that broader problem.
In contrast, conditions in financial markets have continued to improve, with the prices of many risky assets rising and risk premia declining somewhat. Short-term funding markets are almost back to normal with interbank lending spreads remarkably close to their pre-crisis levels. That has fed through to some recovery in property markets, where prices have risen by around 10% since their troughs last spring. Nevertheless, markets in a range of securitised instruments have not re-opened, and are unlikely to do so without fundamental reforms to their design and transparency. And there is a considerable challenge for the banking system to refinance the funding it has obtained with support from the public sector. As the financial sector repairs its balance sheet, other sectors of the economy, especially the public sector, also need to strengthen their finances. As a result, there is likely to be a considerable drag on spending in the economy.
To offset the effects of these headwinds, the MPC decided at its February meeting to maintain the unprecedented level of monetary stimulus, by holding Bank Rate at 0.5% and maintaining the stock of assets purchased over the past year at £200 billion. The effects of the money-financed asset purchases will persist and together with the low level of Bank Rate, will continue to provide a substantial boost to money spending for some time to come. In addition, output in the economy is still benefiting from the effects of the depreciation in sterling that occurred in 2007 and 2008.
Judging how these various factors will play out is an extremely difficult challenge. In part, that is because the effects of the stock cycle, the restoration of the standard rate of VAT to 17½% and even the cold weather in January mean that data are likely to be volatile over the next few months. Last week, I wrote an open letter to the Chancellor to explain why inflation had risen to 3.5% in January - more than a percentage point away from the target. This is the third episode in which I have written such open letters. As in the previous episodes, the Committee believes that the current high level of inflation reflects temporary factors, such as the restoration of the standard rate of VAT to 17½%, higher oil prices and the effects of the exchange rate depreciation continuing to feed through. We are conscious that just four months earlier inflation was 1.1%. And the Committee believes that, although it is likely to remain high for a few months, inflation is more likely than not to fall below the 2% target in the second half of this year as the influence of spare capacity bears down on inflation.
Chairman, our economy has embarked on a process of healing. That will take time. The crisis has left us facing many serious challenges. Among them are how to reform the international financial system, how to reduce our largest peace-time fiscal deficit, and how to restructure our banking and financial system to prevent another, more serious, crisis in future. The crisis did not originate in the non-financial sectors of the economy but that is where most of the costs are falling. You don't need me to tell you that its impact is not just economic but also social and political in nature. Throughout the crisis, your Committee has led the way in putting forward proposals to leave the UK economy better placed to meet those challenges. I thank you for that, and I look forward to working with the Committee again in a new Parliament. With that, I and other members of the MPC here today stand ready to answer your questions. Keywords: BRITAIN BANK/TEXT (London Treasury Desk) COPYRIGHT Copyright Thomson Reuters 2010. All rights reserved. The copying, republication or redistribution of Reuters News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters.