18 July 2016

Bank of England: Brexit and Monetary Policy - speech by Martin Weale

Conclusion: Policy in the Near Term 

You will have seen that the Committee voted in July to keep Bank Rate and asset holdings unchanged. [...] I have tried to set out the very high degree of uncertainty surrounding estimates of the long-term implications for Britain of leaving the European Union. From the perspective of monetary policy a weakening of supply conditions which runs ahead of a weakening of demand would tend to add to inflation while if demand weakens ahead of supply the reverse may be true. With the uncertainty about our long-run arrangements, it is possible that people will reduce their spending, partly because they expect to be poorer in the future, but also because they have become more uncertain about future arrangements and thus future incomes. On the other hand, following the appointment of a new Prime Minister at least some of the immediate sense of uncertainty which followed the vote may have dissipated, and consumers may be more influenced by this than by the technicalities of future trade agreements. Similarly, the appointment of a new government may have left businesses more confident than they were in the immediate aftermath of the vote.

This uncertainty points to the argument that we should wait for firmer evidence before making any policy change and least in the absence of any strong arguments for an immediate change. The argument in the other direction is that, while I am very uncertain about the magnitude of the effect, it does seem to me quite likely that demand will weaken more than supply in the near term. So is there a case for a stitch in time? In considering the case for this I need to take into account other influences on inflation. As I showed earlier, a fall in the exchange rate could imply, other things being equal, an early reduction in Bank Rate which my successors would start to reverse early next year. One argument against adopting this sort of fine tuning is, however, given by recent developments in average earnings. [...]

Looking two to three years ahead, I will, at my final meeting of the Monetary Policy Committee, try to assess any overshoot of inflation beyond its target, whatever their cause, against possible shortfalls in GDP, relative to the way I see the supply capacity of the economy. I have set out how I far I think it reasonable to trade off one against the other but I do not yet have my own estimates of the relative magnitudes that I will need trade off. For there to be a case for easing policy I will need to expect weakness in output to be large enough more than to compensate for any overshoot in inflation on the assumption that policy is unchanged in the near term.

I would like to mention two arguments I have heard for a rate reduction to which I give little weight. This is that markets would be disappointed were there to be no easing in August. The Old Lady of Threadneedle Street is not a nurse to markets. People who trade in markets know that the Monetary Policy Committee sets policy month by month in the way that its members think appropriate. It does sometimes, as we did in our July meeting, give an indication of where policy may go in the future. But that is no more than the best judgement at the time and not in any sense a commitment; the public understand that. A second argument to which I give little weight is the argument that early action is needed to reassure people. In contrast to the experience of 2008, I do not have any sense that either consumers or businesses are panic-struck and, as I observed, there have been no material signs of financial panic.  [...]

Full speech

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