side effects. one was a marked increase in the uk ’ s trade deficit. another was the creation of a monetary climate conducive to strong rises in house prices and consumer borrowing relative to disposable incomes – an experience shared with other countries such as australia and more recently the united states. together with structural and demographic trends, this has helped to push the ratio of both house prices and consumer borrowing to household disposable incomes to levels well outside the range of previous experience. if, against the background of a much flatter housing market, households now go through a period of rather subdued spending, strong external demand would help to support activity and rebalance the economy. but is that in prospect? and what are the risks? on some measures, last year – 2004 – saw the strongest growth in the world gdp in 30 years. while there has been some reduction in growth this year, most forecasters ’ central expectation is that it will not prove very marked. from a uk perspective however, the external conjuncture has been significantly less supportive than this implies. the key point is that the upturn in world growth has been very unbalanced, being driven largely by the us and china. measures of world activity which give a high weight to these two countries paint a pretty buoyant picture, especially those which use purchasing power parities. however, less than 2 % of uk exports go to china and rather less than 20 % to the us. fully 50 % go to the euro area, which has grown only sluggishly, and whose growth forecasts have persistently been revised down. and germany, italy and the netherlands – countries which between them take around 25 % of uk exports – have underperformed the euro average. as a result world gdp weighted by countries ’ importance in uk export markets has shown much a weaker recovery. world price pressures have also been stronger than in recent previous cycles. this largely reflects the sharp rise in the price of oil since early 2004 – a development which seems to have taken almost everyone by surprise. this is a complex story. on the demand side, the relative importance of china and the us in powering the world economy may help to explain why world oil demand grew quite so strongly relative to world gdp last year. this year, however, the sharp rise in prices owes at least as much to supply factors. allowing for these caveats, this is still a much stronger world economic background than, say, 2001. but there are

3 - 7 years ; and there are constraints on refinery capacity which may influence petrol prices. this is bound to have implications for the uk and for our european markets. over the past decade, we have benefited from the downward pressure on imported goods prices exerted directly and indirectly by low cost production in asia. even if these trends continue, as in principle they could for some time, it is becoming increasingly clear that consumers may also need to contend with upward price pressures as world energy markets adapt to meet the needs of emerging asia. the second key area of risk is global imbalances. these pose risks to foreign exchange markets and to world activity. higher oil prices have intensified the scale of the problem. yet we seem no closer to a denouement – indeed, as the us current deficit topped 6 % of gdp, the dollar has tended to strengthen. what does this mean for the uk? i find it extremely hard to predict how sterling ’ s effective rate would be affected, were there to be a major re rating of the dollar. but a resolution of global imbalances which was accompanied by global recession would represent a major challenge for us – one to which, i suspect, we are now less well placed to respond than we were in 2001. finally, there is the puzzling matter of long term interest rates ; last year, as central banks raised their policy rates, long term nominal and real rates fell to levels not seen in 40 years ( though of course, us rates have now ticked up a bit recently ). at the same time, risk premia of all kinds – bond spreads and term premia – have been sharply compressed. this state of affairs has caused a great deal of head scratching, and nowhere more than in central banks. plausible explanations for low risk free real rates include the possibility that there is a global savings glut. it is also argued that there has been an investment ‘ strike ’ almost everywhere except china and maybe the us, perhaps reflecting a persistent overhang from the east asian crisis or the last it cycle. these are speculative explanations, and it is not easy to discriminate between them. however, they all seem to point to a more or less prolonged period of low rates. more worryingly, compressed risk premia of all kinds may reflect a belief that the world is no longer such a risky place, a belief fostered by the period of low inflation that many economies have enjoyed in the past decade. hopefully, low inflation is here to stay