rachel lomax : uk monetary policy – the international context speech by ms rachel lomax, deputy governor of the bank of england, at the apcims annual conference, london, 17 october 2005. * * * those of you who have logged on to the bank of england ’ s website recently will have noticed that it has turned a cheerful shade of orange. it is a lovely website and we are very proud of it. but perhaps now was not the best time to major on pictures of happy shoppers clutching bulging carrier bags! the fact is that website design – like monetary policy - is beset by information problems and lengthy lags. these make it very hard to get the timing of changes just right. when the organisers of this conference pressed me for a title some weeks ago, i decided to talk about the international context for uk monetary policy for two reasons. first, i was fresh from a summer spent reading this year ’ s top business books, whose key theme is the dizzying pace of change in the global economy. but second, i wanted look beyond the shopping story that – understandably – tends to dominate the press, to some of the other factors that have to be weighed when the mpc sets interest rates. but let me start with the recent weakness in retail spending. judging by the latest indicators, this looks like persisting, at least in the near term. but while spending on retail goods has been virtually flat since last autumn, total consumer spending, including services and utilities, has continued to grow, though quite slowly. and while the prospects for consumption are clearly important, so too are those for other key drivers of the economy, such as business investment and net exports. the question is : if consumers decide to save more, are the conditions in place for other sources of demand to take up the slack? the answer depends in part on what is happening in the rest of the world. plainly, developments in the rest of the world will influence domestic monetary policy. the uk is a very open economy, exposed to trends and shocks that affect supply as well as demand, and our financial markets are fully integrated with global markets. sterling is one of the world ’ s most liquid currencies, and the ftse 100 is heavily weighted with multinational companies. let me give one example of what this can mean in practice. over recent years, the progressive shift toward sourcing from low cost producers has been depressing import prices, and improving the terms on which we trade. this

’ s early days still and i don ’ t want to front run any of the important thinking that needs to be done to inform that response. but i did want briefly to offer some thoughts around how we might embed some of the material i ’ ve touched on in this speech into our regular policymaking processes. first, building out our forecast evaluation capabilities – much as i have sought to do through these examples – will mean we can more systematically ask ourselves whether we have learned anything about the shocks that explain past data – and therefore how to think about the mediumterm outlook for inflation. second, as i hope i have shown, we can learn lessons from a range of models to help us identify shocks. [ 19 ] and we can use these models to build the potential for shock uncertainty into our scenario analysis. third, we should routinely be explaining publicly how monetary policy would need to change should we be wrong about the nature of the shocks that are hitting the economy. fourth, we should build more sophisticated analysis of climate policy into our bread - and - butter monetary policy work. there is mounting evidence that it matters for price stability. i plan to return to this in a speech later in the year. and finally, we need to make sure we explain how we are interpreting the data – in terms of its underlying shocks – and therefore what it is telling us about the medium - term outlook for inflation. that will help reduce the sensitivity of market rates to short - term data volatility and that will ultimately ensure that rates are appropriate for the state of the economy. updating my view of the economic outlook the economy has been undergoing waves of adjustment as the effects of the unprecedented shocks of recent years ease off. in informing my view of the outlook from here i find it helpful to look through the volatility in the data and group the shocks that are driving the economy into two buckets. first, there is the lagged effect of the large shocks that hit the economy in the past. the energy price shocks that i talked about earlier imparted downwards pressure on inflation through very mechanical so - called base effects – where headline inflation falls as increases in prices a year earlier are not repeated – and through a cooling effect on demand. but they are unlikely to have much further impact on activity or inflation as we look ahead. you can see that in part in chart 2, where the impact of energy prices on the output gap is estimated to be very flat from this point onwards. monetary policy is