the uk of two key developments. first, the continuing financial crisis in advanced financial markets which has been triggered by the slump in the us housing market ; and second, the renewed build up in global inflationary pressures, associated with soaring energy and food prices. these developments are symptomatic of profound changes in the global economy, as world growth has increasingly been powered by resource hungry emerging markets, and as financial markets in developed countries have taken off and, in the process, become more tightly linked to one another. i will talk about both developments, before coming back to discuss the outlook for inflation and growth in the uk, and the implications for policy. financial crisis the crisis in financial markets last august was triggered by a slump in the us housing market. this, of course, is acting as a direct drag on us activity. any slowing in the us economy stands to affect the uk in the traditional way, through influencing trade flows. the size of this effect will depend on how other trading partners are affected and how policymakers react. but the really striking feature of recent experience has been how the us housing crisis has reverberated through the highly integrated and sophisticated financial markets of north america and western europe. six months after global securitisation markets seized up, in response to uncertainties about the scale and location of losses arising from rising defaults on us sub prime mortgages, some credit markets are still not trading at all, and others remain very illiquid. and each week seems to highlight some new dimension of the ensuing disruption to core financial markets. the crucial task of valuing and disclosing the impact of losses on core banking institutions is still work in progress : important announcements are being made almost daily, and beyond them lies the equally important task of repairing banks ’ balance sheets. the current shortage of liquidity makes the pricing of complex assets even more difficult. at the very least, this reinforces the need for transparency in providing estimates of losses, and descriptions of the best - efforts processes used to produce these estimates. the process of price discovery for many complex asset classes is unlikely to be completed quickly. for assets directly related to us sub - prime, this is unlikely to be before the us housing market stabilises. other structured credit markets are likely to remain illiquid until confidence in the banking sector has been restored, and large financial institutions are willing to take more risk. clearly the situation is still developing. and its impact on the wider economic outlook – global and

to be rapidly reversed. as a result of these developments, producer input and output prices are now increasing faster than at any time since 1990, and import prices have picked up sharply. these cost pressures have not yet fed through fully into consumer prices, but from next month cpi inflation is likely to rise more sharply, in particular reflecting the impact of higher utility bills. there is essentially nothing the mpc can do about this immediate impact on the inflation rate. but its implication for policy depends on whether people recognise the temporary nature of the pick - up in inflation. the mpc ’ s remit in setting interest rates is clear – to keep inflation at 2 %. but we have discretion to decide how fast to return inflation to target, if it is thrown off course by a sharp shock, such as the current surge in world energy prices. so we are not required to raise this estimate is taken from the bank of england financial stability report, october 2007, box 1 ( mapping the financial system ). it comprises the estimates of total global securities markets, less bank deposits. interest rates sharply to counteract the rise in inflation which we expect over the next few months. we can decide what is appropriate in the light of all the circumstances. and the purpose of the open letter regime is to give us an opportunity to explain how we propose to use our discretion. over the years the mpc has explained that it seeks to achieve its inflation objective in the medium term by varying interest rates to steer overall demand relative to supply. if price and wage setters do recognise that the imminent pick - up in inflation will be short - lived, then the implications of the spike for monetary policy, and for the necessary balance of demand versus supply, should be limited. but if price and wage setters start to expect higher inflation to persist, then the committee will need to restrain demand, and so generate some slack in the economy, in order to bring inflation expectations, and inflation itself, back down. clearly therefore it is a matter of intense interest to understand how people form and revise their expectations. unfortunately our understanding is very incomplete. one relevant area of active research is why inflation expectations seem to have been so stable over the past decade – the period of the so - called great stability. one supposition is that well anchored expectations reflect the introduction of credible inflation targeting regimes – people have understood that central banks are focussed on keeping inflation low, and will take action to reduce it if necessary. another view is that people