. 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

”. very few banks fail because they are insolvent today. they don ’ t get that far. typically, they fail because of a rising probability that they are expected to be insolvent at some point ( s ) in the future. this is important because regulating banks has to be forward looking, and in my view has not been adequately so in the past. it also means that a problem in a bank can spread to create a problem in the wider financial system, so called systemic risk. maintaining the stability of the financial system – financial stability – is therefore at the heart of the efforts of the authorities to prevent problems in banks spreading out of control. the financial crisis of the last three and a half years has illustrated starkly what can happen when financial stability is not maintained. so, establishing and maintaining financial stability should be high up everyone ’ s agenda, and we should embed financial stability as the objective of public policy towards regulating the financial system. you can reasonably ask, why is this difficult to achieve? financial stability is difficult to define quantitatively and precisely. some people say that you know it when you have it, but it might be better to say that you know when you don ’ t have it. what is being done to tackle the issue? a month ago, the government issued a consultation paper which seeks to define the financial stability objective that will be given to the new financial policy committee of the bank of england under its plans. the objective is defined at the high level as protecting and enhancing the stability of the financial system of the uk. more precisely, the bank ’ s objective “ relates primary to the identification of, monitoring of, and taking of action to remove or reduce ” risk to the stability of the uk financial system as a whole or to a significant part of the system, “ with a view to protecting and enhancing the resilience of the uk financial system ”. but the paper goes on to include in the objective the statement that : this does not require or authorise the bank “ to exercise its function in a way that would in its opinion be likely to have a significant adverse effect on the capacity of the financial sector to contribute to the growth of the uk economy in the medium or long term ”. here then we have the recognition of the need to have regard to the impact of financial regulation on the long - run growth of the economy. to back this up, the government intends to include in the legislation a power for it to provide the bank with