clearly a limit to how far that can go. but accelerating productivity growth has also increased prospective returns on investment in the us which has contributed to a huge net inflow of capital - in the form of both direct and portfolio investment - which has much more than financed the us current account deficit. the numbers are truly massive. in the 18 months since 1 january 1999 when the euro was introduced the us current account deficit was something over $ 500bn compared with net long - term capital inflows of nearly $ 750bn. meanwhile the eurozone was in small current account surplus but saw net direct investment and portfolio outflows of some $ 275bn. the conventional “ fundamentals ” - which one would still expect to reassert themselves in due course - have been overridden for the time being by these massive international capital flows. to the extent that the capital flows have indeed been driven by an improvement in prospective rates of return in the us associated with the productivity “ shock ” - and i freely acknowledge that this explanation may be oversimplistic - one would expect that at some point it would be discounted through a change in relative asset values, including the change in the exchange rate. the problem is that we simply do not know how close we are to that point - or indeed whether we have already passed it. putting that question to the market was, for me, the real point of the recent g7 intervention. we all need to understand much more about the nature of the capital flows and in particular about what motivates the market participants who initiate them. my immediate point, however, is that on the basis of what we do know it seems unlikely that the euro ’ s weakness in the foreign exchange market is pushed by any obvious macro - economic failure in the eurozone. it is much more likely that it reflects the magnetic attraction of the us at present as a destination for long - term investment. and while that may partly reflect relatively greater flexibility on the supply - side of the us economy, it does not have much to do, as far as i can see, with the introduction of the euro. of course, whatever the cause, the euro ’ s weakness complicates the task of monetary policy within the eurozone. it adds to inflation in itself and amplifies the inflationary effect of the rise in oil prices. the ecb is rightly concerned to ensure that these effects do not feed through into an increase in the rate of core inflation. given the

we implement this strategy successfully, we will be able to provide more durable support for demand and activity. if, by contrast, we were to adopt a course that let the inflation genie out of the bottle, we would find ourselves needing to tighten policy, exacerbating the slowdown in activity. that broad strategy is not a recipe for inaction. the central projection in february ’ s inflation report was for inflation to return to close to the 2 % target over the coming two to three years, conditional on the market ’ s expectation of further cuts in bank rate. but nor does the strategy determine a definite path for bank rate over the coming months. each of us on the mpc must form a judgment month by month on which of the risks to the inflation outlook – from financial conditions or from rising costs – is proving more potent, and so a judgment on the degree to which we can set a course that underpins demand. since the february inflation report, oil prices are around 10 % higher, and sterling ’ s exchange rate around 4 % lower, so the immediate cost pressures are worse. the good news is that, in the labour market, nominal earnings growth has so far remained subdued, notwithstanding the rise in near - term inflation expectations revealed by a range of surveys. this is perhaps suggestive of the adjustment in real take - home pay made necessary by the sharp increase in firms ’ costs due to the further rises in commodity prices. in manufacturing, firms ’ input costs have risen sharply over the past twelve months ; and output price inflation has reached nearly 6 %. a big question is to what extent competition amongst retailers will dampen the pass through into retail prices. anecdotally, retailers still sound as though they are competing fiercely on prices, and driving down other costs in order to maintain their margins. meanwhile, on the other side of the ledger, many essentially backward - looking indicators of uk real demand and activity have held up reasonably well. but we should not yet place great weight on that. it can sometimes take time for disturbances to affect real economic activity. in the united states, arguably there was quite a lag between the onset of problems in housing finance and the pass through to spending. the uk looks to be quite a lot better than the us. the latest data for q4 last year did, however, suggest that household spending on durables slowed quite significantly. and we are seeing softening in consumer confidence and property market conditions. so the picture on the real economy