slowing down. so it is not all obvious to me at least that the household sector will suddenly run for cover in the current environment, where the labour market remains remarkably robust, and the prospect for inflation - and hence the prospect for interest rates - remains relatively benign, remaining somewhat above target in the near term but moving down gradually as we move into next year. i don't say that things could not turn out rather worse than that - and there are other uncertainties, like development of the exchange rate, or the effect of the upcoming increase in national insurance contributions, which i have not touched upon this evening. uncertainty is a fact of economic life. but i do say that it would be unwise - as some have implied - to set monetary policy on the basis of the worst possible outcome, even if one knew what that would actually mean in policy terms. at the time of our last inflation report published in november the mpc's collective view of the most likely outcome for the uk, looking over the next two years, was for growth at around trend with inflation close to target. but we were - and we remain - acutely conscious of the uncertainties and risks around that prospect. and we review the position intensively both at our regular monthly policy meetings and in the context of our quarterly forecasting round. and in that context, i give you my assurance that, despite the fact that we have not changed interest rates now for over a year, we stand ready to do so at any time if and when we see the risks to our central expectation beginning to crystallise in either direction. mr president, let me conclude by suggesting once again this year that yes, we can keep the uk economy moving forward, but i don't pretend that it will be easy. sadly i am attending this dinner for the last time as governor this evening, so i will not be accountable to you for how we get on. but i will leave the bank of england in the good hands of my successor, mervyn king, when i step down in june, and i have every confidence that he will, by the time of your next dinner, have a positive story to tell.

. but the serious downside risks to the economic outlook we saw then have since receded. the uk economy has actually bounced back more strongly than in previous recoveries, supported by both domestic and overseas demand. according to data from the council for mortgage lenders, both house repossessions and arrears peaked in the recent recession at lower levels than in the early 1990s, and the numbers have been falling since early 2009. these upside pressures on inflation from import prices and vat have been one reason that inflation has not fallen back in the way we expected in the aftermath of recession. the other significant factor is that spare capacity has not exerted as much downside pressure on cost and price increases as expected. that is partly because the margin of spare capacity appears to be less than we have seen in previous economic cycles. in the labour market, this is the flip - side of the resilience of employment and a lower level of unemployment relative to the early stages of previous recoveries. but survey evidence also suggests that there is limited spare capacity within firms to take up the slack as demand recovers. 12 for example, the most reliable measure of capacity utilisation in manufacturing – the cbi industrial trends survey – shows capacity utilisation at around its average level, which is quite surprising at this stage of the recovery. there is more survey evidence of spare capacity in the services sector. but this does not seem to be exerting much downward pressure on inflation. the cpi measure of services price inflation has picked up from 2. 4 % at the end of last year to average around 3. 8 % in recent months. this is considerably in excess of the 2 % target and also slightly above the average rate of services price inflation we experienced during the decade prior to the financial crisis, as chart 7 shows. this does not appear consistent with the view that spare capacity in the uk services sector is serving to hold down inflation. with the economy recovering at home and abroad, inflation above target and set to rise further, i believe there are three powerful arguments for a gradual rise in interest rates which have been evident for several months. first, the main elements of demand for uk businesses – overseas markets and domestic private sector spending – have been recovering for over a year now and look set to continue to grow. the outlook for growth suggests the uk economy should be able to withstand a gradual rise in interest rates, even taking into account the impact of fiscal consolidation. indeed, it is worth noting