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Quarterly Bulletin Autumn 2004 Bank of England Volume 44 Number 3 Bank of England Quarterly Bulletin Autumn 2004 Summary 263 Recent economic and financial developments Markets and operations 265 Box on search for alpha 272 Box on management of the Bank’s sterling bond portfolio 279 Research and analysis How should we think about consumer confidence? 282 Box on how is consumer confidence measured in practice? 283 Box on comparisons with consumer confidence surveys in other countries 285 Household secured debt 291 Housing equity and consumption: insights from the Survey of English Housing 302 Box on how does equity withdrawal vary by household income? 304 Why has world trade grown faster than world output? 310 Summaries of recent Bank of England working papers Health, disability insurance and labour force participation 321 Female labour force participation in the United Kingdom: evolving characteristics or changing behaviour? 322 The roles of expected profitability, Tobin’s Q and cash flow in econometric models of company investment 323 Real exchange rates and the relative prices of non-traded and traded goods: an empirical analysis 324 The informational content of empirical measures of real interest rate and output gaps for the United Kingdom 325 Exploring the relationship between credit spreads and default probabilities 326 Corporate capital structure in the United Kingdom: determinants and adjustment 327 The Phillips curve under state-dependent pricing 328 The UK labour force participation rate: business cycle and trend influences 329 On the resolution of banking crises: theory and evidence 330 Financial interlinkages in the United Kingdom’s interbank market and the risk of contagion 331 Speeches The institutions of monetary policy Speech by the Governor given at the American Economic Association Annual Meeting in San Diego, on 4 January 2004 332 The Governor’s speech to the CBI Scotland dinner Speech by the Governor given on 14 June 2004 346 The Governor’s speech at the Mansion House Speech by the Governor on 16 June 2004 349 Keeping the party under control—anniversary comments on monetary policy Speech by Rachel Lomax, Deputy Governor and member of the Monetary Policy Committee, delivered at the Annual Luncheon of the British Hospitality Association on 1 July 2004 352 Some current issues in UK monetary policy Speech by Charles Bean, Chief Economist and member of the Monetary Policy Committee, delivered to the Institute of Economic Affairs on 28 July 2004 355 Managing the central bank’s balance sheet: where monetary policy meets financial stability Lecture by Paul Tucker, Executive Director of the Bank of England and member of the Monetary Policy Committee, delivered on 28 July 2004 359 Household debt, house prices and consumption growth Speech by Stephen Nickell, member of the Bank’s Monetary Policy Committee, given at Bloomberg in London on 14 September 2004 383 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 44 Number 3 Printed by Park Communications © Bank of England 2004 ISSN 0005-5166 Quarterly Bulletin—Autumn 2004 Markets and operations This article reviews developments since the Summer 2004 Quarterly Bulletin in sterling (pages 265–81) and global financial markets, in UK market structure and in the Bank’s official operations. Research and analysis Research work published by the Bank is intended to contribute to debate, and (pages 282–320) does not necessarily reflect the views of the Bank or of MPC members. How should we think about consumer confidence? (by Stuart Berry of the Bank’s Sterling Markets Division and Melissa Davey of the Bank’s Conjunctural Assessment and Projections Division). In the United Kingdom, movements in confidence have been closely related to annual real consumption growth over the past 30 years. But both these series have common determinants. This article shows that the standard economic determinants of consumption such as income, wealth and interest rates can ‘explain’ a large part of the movements in consumer confidence. However, confidence is also affected by non-economic events, or may react in a complex manner to unusual economic events. We find that such ‘unexplained’ movements in consumer confidence do not appear to be closely related to households’ spending decisions on average. So although consumer confidence indices are published well ahead of official data on consumer spending it is important to consider why confidence has changed before assessing its likely implications for consumption. Household secured debt (by Matthew Hancock of the Bank’s Monetary Assessment and Strategy Division and Rob Wood of the Bank’s Structural Economic Analysis Division). Deteriorating household sector balance sheets were widely thought to have exacerbated the recession in the early 1990s. In recent years households have once more significantly increased their indebtedness; this has been matched in aggregate by an accumulation of financial assets. This article analyses homeowners’ financial positions since the late 1980s using disaggregated data, to assess the extent to which debt may exert an important influence on the macroeconomy in the current conjuncture. Housing equity and consumption: insights from the Survey of English Housing (by Andrew Benito of the Bank’s Structural Economic Analysis Division and John Power of the Bank’s Inflation Report and Bulletin Division). This article examines data from the 2003 Survey of English Housing (SEH) in order to shed light on the link between gross equity withdrawal and spending. Our analysis suggests that the bulk of gross withdrawals is not consumed in the near term. Those who sell a property without purchasing another one and those who trade down are more likely to pay off debt or save withdrawn equity than spend the proceeds. Remortgagors and those who obtain further secured advances are likely to spend the equity, but we estimate that their equity constitutes only about a quarter of total gross withdrawals. Of those who spend equity, financing home improvements rather than purchasing consumer goods appears to be the most important use of funds. That is consistent with the relatively weak relationship between consumption and mortgage equity withdrawal recently observed in aggregate data. 263 Bank of England Quarterly Bulletin: Autumn 2004 Why has world trade grown faster than world output? (by Mark Dean of the Bank’s International Economic Analysis Division and Maria Sebastia-Barriel of the Bank’s Structural Economic Analysis Division). Between 1980 and 2002, world trade has more than tripled while world output has ‘only’ doubled. The rise in trade relative to output is common across countries and regions, although the relative growth in trade and output varies greatly. This article attempts to explain why the ratio of world trade to output has increased over recent decades. It provides a brief review of the key determinants of trade growth and identifies proxies that will enable us to quantify the relative importance of the different channels. We estimate this across a panel of ten developed countries. This will allow us to understand better the path of world trade and thus the demand for UK exports. Furthermore this approach will help us to distinguish between long-run trends in trade growth and cyclical movements around it. 264 Markets and operations This article reviews developments since the Summer Quarterly Bulletin in sterling and global financial markets, in market structure and in the Bank’s official operations.(1) " International short-term nominal forward interest rates fell, as market participants appeared to revise downwards their views on the likely future path of monetary policy. Nominal forward rates at longer maturities also fell. " Equity markets were little changed and, except in Japan, remained close to the levels prevailing at the start of 2004. Credit spreads narrowed, particularly on high-yield and emerging market bonds. " Measures of implied and realised volatility have generally been low across financial markets. " The Bank announced on 22 July the main results of its review of its operations in the sterling money markets. As had been widely anticipated, official interest rates in This revision to market expectations about future both the United Kingdom and the United States were interest rates followed higher oil prices and mixed US raised over the period, each by 50 basis points in two data releases (particularly weak labour market statistics 25 basis point moves. But market participants’ views on for June and July), prompting some commentators to the likely future path of monetary policy were revised question the strength of the US recovery. Economists’ downwards, with international short-term nominal forecasts for US GDP growth in 2004 were revised forward rates falling by between 9 and 24 basis points downwards in July and August, having ticked up slightly (Table A). in June (Chart 1). Conversely, forecasts for 2004 GDP growth for the euro area and the United Kingdom rose Table A Chart 1 Summary of changes in market prices Expected real GDP growth 28 May 3 Sept. Change Dashed lines are 2005 forecasts Solid lines are 2004 forecasts Per cent December 2004 three-month interbank 5 interest rate (per cent) United Kingdom 5.34 5.10 -24 bp Euro area 2.37 2.28 -9 bp United States 2.42 2.32 -10 bp United States 4 Ten-year nominal forward rate (per cent) (a) United Kingdom 4.95 4.84 -10 bp Euro area 5.47 5.18 -28 bp United States 6.72 6.37 -35 bp 3 United Kingdom Equity indices (domestic currency) FTSE 100 index 4431 4551 2.7% Euro Stoxx 50 index 2737 2739 0.1% 2 S&P 500 index 1121 1114 -0.6% Euro area Exchange rates Sterling effective exchange rate 105.8 103.4 -2.3% Japan 1 $/€ exchange rate 1.22 1.21 -0.8% Columns may not correspond exactly due to rounding.
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