Without absolute clarity about the objectives of any macro-prudential policy framework and the policy rule necessary to deliver these objectives, expectations will not adjust and policy will be impotent. Any lack of transparency or failure of communications is likely to inhibit seriously the effectiveness of macro-prudential policy. Sixth, because macro-prudential policy is new in most developed countries, there are understandable concerns that policymakers’ knowledge of the transmission mechanism of policy is incomplete and imperfect. The model of the credit cycle developed here offers some grounds for optimism. Signalling is the key transmission channel. Quantitative estimates of the effects of, for example, higher capital ratios on banks’ cost of credit provision have wide confidence intervals (BIS (2010)). But this may not be fatal if macro-prudential policy by-passes these channels and works by acting, first and foremost, through expectations. Seventh, the credit cycle is increasingly an international phenomenon, as well as a national one. Credit spillovers occur across borders as well as across banks. This suggests macroprudential policies need also to have an international dimension if they are to tackle credit externalities. This is recognised in the macro-prudential policy framework currently being discussed by the international regulatory community (BIS (2010)). This framework includes an explicit reciprocity provision. For example, judgements on local credit conditions determine the amounts of capital to be held by international banks on their exposures in  24  BIS Review 168/2010  those countries. This reciprocity feature should help to reduce the arbitrage risks posed by the internationalisation of the credit cycle.

Some near term sources of uncertainty have eased but others remain. Because of the Government’s Energy Price Guarantee there is more certainty about the outlook for energy prices and Government policy more broadly is on a more stable and predictable footing. This has been reflected in pricing in financial markets. The labour market remains tight and services inflation has hit 30-year highs and is contributing more to overall inflation. I am not yet confident that domestically generated inflationary pressures from increased costs and firms’ pricing are starting to ease. Encouragingly survey and market based medium term inflation expectations have fallen back from their peak, though they remain elevated. Assuming that in the near term the economy evolves broadly in line with the latest MPR projections and given my assessment of the balance of risks, then I expect that further increases in Bank rate are going to be required to ensure a sustainable return of inflation to target. Considerable uncertainties remain around the outlook and if the outlook suggests more persistent inflationary pressures then I will continue to vote to respond forcefully. At the same time I am mindful that there are other uncertainties that I haven’t covered today, for example relating to the transmission mechanism for policy. We have increased Bank Rate very rapidly over the last year and on past experience a change in interest rates has its peak impact on inflation only after around 18-24 months.