The Rt Hon Sir Edward George GBE: Recent UK economic developments
against the background of world economic activity
Speech by The Rt Hon Sir Edward George GBE, Governor of the Bank of England, at the Chartered
Institute of Bankers in Scotland Biennial Dinner at the Exchange, held on 15 January 2001.
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Mr President, Lord Provost, my Lords, Ladies and Gentlemen,
This is the fourth occasion on which I have been honoured to be invited to speak at this great biennial
dinner of the oldest Institute of Bankers in the World; and it gives me particular pleasure this evening
to join you in celebrating your 125th anniversary.
On the three previous occasions I have been able to report to you steady progress of the overall UK
economy, but then, as a central banker brought up to look for the dark side of the moon, I've gone on
to discuss the prevailing risks and uncertainties and to pose the question: can that steady progress be
maintained? I will adopt the same format this evening.
Since your last dinner in 1999, we have in fact, come through the short, sharp, shock to the world
economy, associated with the emerging markets financial crisis, relatively unscathed. Our own
economy has now grown continuously quarter by quarter for over 81⁄2 years at an average annual rate
of 3%, which is well above most estimates - at least until recently - of a longer term trend rate of
21⁄421⁄2%. Retail price inflation (on the Government's target measure) has averaged 2.7% over this period,
and has in fact been marginally below the 21⁄2% target for much of the past two years. Short- -term
interest rates - which went up to 12% (and tentatively even to 15%) before we left the ERM in 1992
have been stable at 6% for the best part of a year. Helped by a decline in inflationary expectations, UK
10 year Government bond yields have fallen, to around 43⁄4% which, apart from a brief period at the
beginning of 1999, is the lowest they've been for nearly 40 years. They are now just about as low as in
any major industrial country with the exception of Japan.
And the number of people in work has recently been at an all-time high in the UK as a whole - and
close to its high point in Scotland; while the rate of unemployment, on a claimant count basis, is at a
25-year low, both in the UK as a whole and in this country.
The question remains - can we keep it up? The answer to that question depends on developments
both at home and abroad, but let me comment first on the international situation which is currently the
focus of a great deal of attention.
The bounce back from the world economic slowdown in 1998/1999 was such that in the year just
ended world economic activity grew at a rate of some 41⁄2% which equals the fastest rate for 16 years
- and compares with an average rate of some 31⁄4% over the last 10 or 20 years. In large part this
recovery was underpinned by unusually strong growth in the US, averaging some 41⁄2% over the past
4 years and surging to a peak of some 51⁄2% at an annual rate in the first half of last year - compared
with an average rate of 23⁄4% over the preceding decade. This remarkable strength of the US economy
was possible, without overheating, against the background of unusually rapid productivity growth as
investment in IT spread through the US economy improving its supply-side capacity. These
developments together implied higher corporate earnings growth in the US pushing up the stock
market and at the same time attracting massive direct and portfolio capital inflows into the US -
substantially from the Eurozone - which comfortably over-financed a burgeoning US current account
deficit and underpinned the strong dollar.
However helpful all this was in supporting the world economy it clearly could not continue for ever or
without limit. At some point - and no-one could know at all precisely at what point - demand in the US
would begin to outstrip supply and the growing external imbalance between the US and the rest of the
world would become unsustainable; relative asset prices - including the dollar's exchange rate -
would over-discount prospective US corporate earnings growth and both equity and foreign exchange
markets would then become vulnerable to abrupt correction.
Against that background it has been clear for some time that there needed to be a slowdown in the
growth of the US economy to a rate which was more sustainable, both in the US itself but also in
terms of the imbalance within the global economy - and the debate turned to whether it would come
as the "soft landing" we would all welcome or a more disruptive "hard landing" which we could all well
do without.
And slowdown, of course, is what we have seen over the past six months. In the third quarter US GDP
growth fell to an annualised rate of some 21⁄4% - less than half that in the earlier part of last year, and
much of the more recent data suggest a further weakening. This slowdown has been reflected in a fall
in equity prices - including a sharp fall in the previously hugely overblown "tech-heavy" NASDAQ
index; and this in turn has contributed to a typically rapid escalation in the florid language of
commentators, from slowdown, to downturn or recession, to possible slump (though I haven't yet seen
meltdown as we did in 1998), which many of the commentators appear to regard as near-synonyms.
Of course it is always possible that it will come to this - no-one has a crystal ball - and it goes without
saying that we are all watching what's happening very carefully. But that is not my own view of the
most likely outcome, nor that of my central bank colleagues from around the world when we met in
Basel a week ago. We met in the wake of the Fed's move to cut interest rates which was widely
welcomed as timely and appropriate, demonstrating sensitivity to the possibility of a spiralling decline
in financial market and business and consumer confidence. We noted, too, that in announcing its
move the Fed had made a point of emphasising its expectation of continuing relatively strong
productivity growth, giving it more room for manoeuvre than it would otherwise have. Against that
background, the view was that, while the US economy might be in for a bumpy ride over the next few
months, associated for example with inventory adjustment in the motor industry, the likely outcome for
this year as a whole is that the US economy will continue to grow by perhaps 2-3%, and that the
overall world economy - helped by steady growth in the Eurozone - would again this year grow
probably somewhat above its longer-term average rate. That, certainly, is a slowdown in the recent
rate of growth - and a downward revision of earlier expectations of growth for the current year; but it is
not a downturn in the sense of contracting activity. On this view, the slowdown in prospect would have
relatively benign effects in terms of the longer term sustainability of the global economic expansion;
and developments so far have already had positive effects both in terms of their impact on the world
oil price, and in terms of their impact on the pattern of exchange rates, notably by reducing the
exaggerated weakness of the euro.
On that basis the global economic environment should provide a reasonable background for our own
economy. We - and our partners in the European Union - would be relatively little affected by the US
economic slowdown. The world economy as a whole would certainly be helped by the somewhat
softer oil price - though I appreciate there may be mixed views on that up here in Scotland. And the
recovery of the euro - including its recovery against sterling - will help to ease the severe imbalance
within our own economy between the domestically-orientated sectors which have typically been doing
relatively well and those businesses and sectors that are most exposed to competition from the
Eurozone and which have been having a rough time. That imbalance is, I know, a real concern up
here north of the border, and it has more generally for some time been one of the most difficult issues
confronting us in conducting monetary policy.
But there are, of course, also major domestic uncertainties. What - as I have often explained before -
we are seeking to do through monetary policy - in order to achieve the Government's inflation target -
is to keep overall nominal demand growth more or less continuously in line with the supply-side
capacity of the economy to meet that demand. That is a necessary condition for maintaining our
steady economic progress. But we cannot directly observe supply-side capacity in either product or
labour markets, nor therefore anticipate just how it will develop, with any great precision, nor do we
know precisely what is currently happening or is likely to happen to the rate of growth of aggregate
demand in the economy anyway. Our forecasts and policy judgements are based upon very careful
scrutiny of all the latest data available to us, informed by the best technical analysis we can muster.
But they necessarily remain our best judgements and that, of course, leaves us vulnerable to
assertions that we do not give sufficient weight to this or that factor.
For what it is worth, at the time of our last forecast in November, our central projection - on the
assumption of 6% interest rates - was for output growth of around 21⁄2% over the next couple of years,
with RPIX inflation remaining modestly below target this year but rising to 21⁄2% in 2002. There was, of
course, a good deal of uncertainty around that central projection, as there always is, for the reasons
that I've tried to explain. But on the basis of that forecast the short answer to the question: can our
steady economic progress be maintained over the next couple of years is a cautious "yes".
Since that forecast was completed things have gone in different directions. The prospect for external
demand has somewhat weakened and so too has the oil price. There are mixed messages relating to
tightness in the labour market, but earnings growth has so far remained reasonably well contained - as
it must continue to do. On the domestic demand side, private consumption growth has remained
stronger than we had supposed, while the growth in private investment has been weaker; meanwhile it
is not clear that underlying public sector demand has - at least yet - picked up as rapidly as planned.
The exchange rate has fallen, and so, too, have market interest rates.
I would not venture to suggest how these - and all the other developments we look at - will influence
our next forecast in February; and it would be pointless to anticipate possible future policy decisions. I
would be surprised if they radically altered the broad prospect of relatively steady progress over the
next two years. But I can assure you of one thing: if the prospect - or the balance of risks around it
were to change significantly - either in the context of our February forecast or subsequently - we will
promptly react to that change. Despite the fact that we left interest rates on hold again last week, we
have certainly not gone to sleep! We cannot guarantee that we will always remain as close to the
symmetrical inflation target as we have been in recent years - the uncertainties as I have explained
are too great for that degree of confidence. But that remains our aim. And I will be happy to report
back to you again at your next dinner.
Let me, Mr President, just conclude by congratulating you and the Chartered Institute on your
achievements - not just over the past two years though I do congratulate you on that, especially, if I
may, on your introduction of your new Chartered Banker qualification. But I congratulate you more
broadly on your achievements over the whole 125 years since your foundation. And let me invite all
your guests now to rise and to join me in wishing you well over the next 125 years.
Ladies and Gentlemen, please join me in a toast to the continuing achievements of the Chartered
Institute of Bankers in Scotland.