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Quarterly Bulletin Spring 2003 Quarterly Bulletin Spring 2003 Bank of England Volume 43 Number 1 Bank of England Quarterly Bulletin Spring 2003 Summary 3 Recent economic and financial developments Markets and operations 5 Box on UK life insurance companies 13 Box on components of the Bank of England’s balance sheet 18 Research and analysis Market-based estimates of expected future UK output growth 20 Monetary policy and the zero bound to nominal interest rates 27 The measurement of house prices 38 Box on hedonic regressions 40 Summaries of recent Bank of England working papers House prices, consumption, and monetary policy: a financial accelerator approach 47 Base rate pass-through: evidence from banks’ and building societies’ retail rates 48 Leading indicators of balance-of-payments crises: a partial review 49 Public demand for low inflation 50 Current accounts, net foreign assets and the implications of cyclical factors 51 Money market operations and volatility of UK money market rates 52 Equilibrium analysis, banking, contagion and financial fragility 53 Rational expectations and fixed-event forecasts: an application to UK inflation 54 The provisioning experience of the major UK banks: a small panel investigation 55 The impact of price competitiveness on UK producer price behaviour 56 A Kalman filter approach to estimating the UK NAIRU 57 The role of expectations in estimates of the NAIRU in the United States and the United Kingdom 58 Procyclicality and the new Basel Accord—banks’ choice of loan rating system 59 Reports Report on modelling and forecasting at the Bank of England 60 Bank’s response to the Pagan Report 89 The Bank’s regional Agencies 92 Box on an historical perspective 93 Areview of the work of the London Foreign Exchange Joint Standing Committee in 2002 97 Speeches Speech at the Chartered Institute of Bankers in Scotland Biennial Dinner Speech by the Governor, given in Glasgow on 20 January 2003 102 Economists and the real world Speech by Charles Bean, Chief Economist, to commemorate a century of economics teaching at the London School of Economics, given on 29 January 2003 105 Adjusting to low inflation—issues for policy-makers Speech by Kate Barker, member of the Bank’s Monetary Policy Committee, delivered at the Manchester Statistical Society Meeting, on 18 February 2003 113 Six months on the MPC: a reflection on monetary policy Speech by Marian Bell, member of the Bank’s Monetary Policy Committee, delivered to the CBI South East in Crawley, Sussex, on 9 December 2002 125 House prices, household debt and monetary policy Speech by Stephen Nickell, member of the Bank’s Monetary Policy Committee, given at a private dinner for Glasgow Agency contacts, on 11 December 2002 131 The contents page, with links to the articles in PDF, is available at www.bankofengland.co.uk/qbcontents/index.html Authors of articles can be contacted at [email protected] The speeches contained in the Bulletin can be found at www.bankofengland.co.uk/speech/index.html Volume 43 Number 1 Printed by Park Communications © Bank of England 2003 ISSN 0005-5166 Quarterly Bulletin—Spring 2003 Markets and operations This article reviews developments in sterling and global financial markets, UK market (pages 5–19) structure and the Bank’s official operations since the Winter Quarterly Bulletin. Research and analysis Research work published by the Bank is intended to contribute to debate, and (pages 20–59) does not necessarily reflect the views of the Bank or of MPC members. Market-based estimates of expected future UK output growth (by Ben Martin and Michael Sawicki of the Bank’s Monetary Instruments and Markets Division). This article derives some simple market-based projections of future output growth from a Taylor monetary policy rule, yield curves and inflation surveys. The results can be used as a timely cross-check on output growth expectations from other sources. We find that over the recent past the projections have been plausible in magnitude against both recorded outturns and survey expectations. Monetary policy and the zero bound to nominal interest rates (by Tony Yates of the Bank’s Monetary Assessment and Strategy Division). Some commentators have recently discussed the possibility that certain countries may experience a period of general price deflation. In such a situation, nominal interest rates may reach their lower bound of zero. This article concludes that the evidence available suggests that such a situation is highly unlikely to occur in the United Kingdom. It reviews what the academic literature has to say about the scope for alternatives to cutting interest rates in the improbable event that nominal interest rates do reach zero. The measurement of house prices (by Gregory Thwaites and Rob Wood of the Bank’s Structural Economic Analysis Division). House prices are an important consideration in assessing macroeconomic developments in the United Kingdom. But the special characteristics of housing—heterogeneity, infrequent sale and negotiated prices— give rise to important issues that complicate their measurement. There are several valid concepts of house prices—such as the average transaction price, the price of a typical house and the housing stock deflator—each of which is useful for a different purpose. Users must therefore be careful to match the measure they use with the concept of house prices they are interested in. Furthermore, all the available measures are volatile, so high-frequency changes in house price inflation should not be expected to persist. Reports Report on modelling and forecasting at the Bank of England. Report to the Court of (pages 60–101) Directors of the Bank of England on the modelling and forecasting systems within the Bank, prepared by Adrian Pagan of the Australian National University and the University of New South Wales. The Bank’s regional Agencies (by Phil Eckersley, the Bank’s Agent for Northern Ireland and Pamela Webber, of the Bank’s Inflation Report and Bulletin Division). This article describes the work of the Bank’s regional Agencies, updating that published in the November 1997 Quarterly Bulletin. It outlines, in particular, the contribution of the Agencies to the work of the Monetary Policy Committee. 3 Bank of England Quarterly Bulletin: Spring 2003 Areview of the work of the London Foreign Exchange Joint Standing Committee in 2002. This note reviews the work undertaken by the London Foreign Exchange Joint Standing Committee during 2002. 4 Markets and operations This article reviews developments in sterling and global financial markets, UK market structure and the Bank’s official operations since the Winter Quarterly Bulletin.(1) " Forward sterling interest rates over the next five years fell significantly as the yield curve steepened, and the sterling ERI declined to a four-year low. " This was against a background of broadly similar declines in euro and US dollar interest rate expectations and falls in equity markets globally, consistent with reduced expectations for global economic growth over the next few years. " But it is difficult to disentangle the financial market effects of uncertainties relating to a possible war with Iraq. Indicators of uncertainty in financial markets give a mixed picture. " The value of trades, including in sterling, settling through Continuous Linked Settlement has continued to increase, further reducing settlement risk in the global foreign exchange market. " Work continues to allow money market instruments to be dematerialised, and issued and settled in CREST from September 2003, with the Bank planning to publish finalised pro forma terms of issue for these securities in early summer. " CRESTCo also plans to introduce a new mechanism for settlement of term general collateral repo transactions, which might bring a welcome reduction in intraday payment flows and exposures among settlement banks and their customers. " The Bank increased the size of its euro note programme by issuing the first €1 billion tranche of a 2006 note at 7 basis points below the three-year swap rate. Sterling markets Chart 1 Changes in implied forward rates(a) Basis point changes since 22 November 2002 During the review period, the expected path of future 40 sterling interest rates over the next few years, derived from market prices, declined materially (Charts 1 and 2). United Kingdom 20 + Broadly similar changes occurred in euro and US dollar 0 markets, suggesting that the main underlying factors – Euro area were international rather than specific to the United 20 (2) Kingdom. 40 United States The Monetary Policy Committee (MPC) changed the 60 Bank’s repo rate once during the period, reducing it by 80 0.25 percentage points to 3.75% on 6 February 100 (Chart 3). The Bank’s repo rate had been 4% since 24681012 14 16 18 20 22 24 26 Years ahead 8 November 2001, the longest period of unchanged (a) Six-month forward rates derived from the Bank’s government liability official UK interest rates since the period from curves. (Estimates of the UK curve, and of instantaneous forward rates, are published daily on the Bank of England’s web site at February 1964 to June 1965. The rate reduction was www.bankofengland.co.uk/statistics/yieldcurve/main/htm.) followed by sharp falls in money market interest rates. year. Prior to the announcement, a Reuters poll Market participants reported that they had not suggested that economists had attached a mean anticipated a reduction until the second quarter of the probability of 20% to a quarter point rate reduction on (1) The period under review is 22 November 2002 (the data cut-off for the previous Quarterly Bulletin) to 3 March 2003. (2) On 6 March 2003, shortly after the end of the review period, the European Central Bank reduced its official interest rate by 0.25 percentage points to 2.5%. 5 Bank of England Quarterly Bulletin: Spring 2003 Chart 2 6 February.
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