will follow the creation of the prudential regulation authority. the challenge facing monetary policy is obvious – the combination of high consumer price inflation and weak economic growth. both of these might seem surprising given the large amount of spare capacity in the economy. but the rise in world energy and other commodity prices, and the need to reduce both the external and budget deficits, are squeezing real living standards, pushing up on consumer price inflation and slowing domestic consumption. the big picture is that the uk economy is going through a major rebalancing of demand and output, from private and public consumption to net exports and business investment, which will take several years to complete. a necessary precondition for that rebalancing was a fall in the real exchange rate. markets anticipated that need. the nominal effective sterling exchange rate fell by around 25 % between the start of the crisis in 2007 and the beginning of 2009, since when it has been broadly stable. the monetary policy committee ( mpc ) decided to look through the first - round effects of this depreciation on the price level. we could have made a different judgement. we could have raised bank rate significantly so that inflation today would be closer to the target. but that would not have prevented the squeeze on living standards arising from higher oil and commodity prices and the measures necessary to reduce our twin deficits. and it would have meant a weaker recovery, or even further falls in bis central bankers ’ speeches output, despite our having experienced the worst downturn in output and spending since the great depression. to force nominal wages below their already depressed level would have meant much higher unemployment, a greater erosion of living standards, a marked degree of “ undesirable volatility in output ” ( contrary to our remit ), and a risk of inflation falling well below the target in the medium term. with the freedom granted from having our own currency, the mix of tight fiscal and loose monetary policy is necessary for a rebalancing of the economy. because of the measures taken to reduce the enormous fiscal deficit here at home, uk sovereign debt funding costs have actually fallen relative to those in germany since the start of last year. of course, there can always be differences of judgement about the overall stance of policy, but to change the broad policy mix would make little sense. of course, at some point, bank rate will need to rise to more normal levels in order to ensure that inflation returns to its 2 % target. there has been,

mr. george comments briefly on the global economy and on recent economic performance in the united kingdom speech by the governor of the bank of england, mr. e. a. j. george, at the dinner with the lord mayor for bankers and merchants of the city of london on 11 / 6 / 98. the past year, since we last enjoyed the generous hospitality of the mansion house, on this great city of london occasion, has been a testing time. it has been characterised by major imbalances in both the global economy and here in the united kingdom - which have complicated the task of policy - makers everywhere, including the task of the bank of england ’ s now legitimised monetary policy committee. internationally there has been good news in the enviable performance of the united states - goldilocks - economy, with continuing robust domestic demand growth and further falls in unemployment, with so far remarkably little inflationary pressure. to the extent that this performance can be sustained, it provides substantial underpinning for the global economy as a whole. and there has been encouraging news, too, in the re - emergence of domestic demand growth in the continental european countries as they prepare to take the final step to monetary union. that is a promising context for the launch of a strong, credible, currency and i wish the european central bank every success in its historic task. domestic expansion with monetary stability within europe is in the interest of us all. elsewhere though the international situation has been decidedly less benign. a combination of financial fragility and weak business and consumer confidence has weighed heavily on the japanese economy, and on the yen ; and the financial thunderstorms, which broke initially last year over a number of other countries in asia, are still intermittently rumbling around the region and elsewhere. the economic fallout from these developments poses a serious downside risk to the growth of world activity and threatens the emergence of potentially large international payments imbalances. it is a dangerous environment. all of this has prompted a far - reaching re - examination of the international monetary structure, and in the meantime it presents the international monetary authorities with some difficult immediate management challenges. it also, of course, represents an uncertain international background for the conduct of monetary policy in this country. our own overall economic performance over the past year was again very encouraging. output growth ( on the latest data, to the first quarter of this year ) was 2. 9 % significantly above the rate of inflation ( measured by the gdp deflator