Bank defends interest rate rise

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The Independent Online
MEMBERS OF the Bank of England's Monetary Policy Committee, which sets interest rates each month, went on the offensive this weekend against critics of their methodology and actions.

Professor Sir Alan Budd, Mervyn King and DeAnne Julius, all robustly defended the MPC and its actions in the wake of fierce criticism of their recent decision to raise interest rates.

Mervyn King, deputy governor of the Bank of England, rounded on City commentators, saying the reason they were unhappy with the decision was that they had failed to predict it and their employers might therefore have lost money in the markets. There was a similar message from Sir Alan Budd, who said that City economists had difficulty admitting they got it wrong and therefore argued that it was the MPC which had failed to deliver the right policy.

Mr King told Bridge News at a conference in Stockholm: "I think the commentators in the UK were unhappy about the interest rate rise because they failed to tell their bosses that interest rates might go up and therefore probably saw some of their bonuses disappear.

"They deserve to lose that bonus because they focused far more on the interpretation of the MPC as a battle between two teams, hawks and doves, without realising every member of that team has to work to a target".

DeAnne Julius argues in The Independent today that too little attention has been paid to the implications of the fact that services now make up two-thirds of national output. She writes that, on top of the difficulties in measuring growth and inflation when services are dominant, the fact that less capital is needed, typically, for services than manufacturing means a bigger rise in interest rates might be needed to dampen overall demand in the economy.

Ms Julius says: "The rising share of services in output could mean that interest rates would have to move more over the course of the economic cycle. This would make manufacturing more cyclical, bearing the brunt of higher borrowing costs."

Research is under way at the Bank of England to investigate the consequences for monetary policy of the steady shift away from manufacturing. The Bank's economists have also been concerned for some time that official statistics are dominated by manufacturing, with some of the main information about services coming instead from business surveys.

The significance of the article by Ms Julius is that she is the MPC member who argued for a reduction in rates in May, according to recently published minutes of that meeting. The fact that the most "doveish" member of the committee has drawn attention to the need for services to slow down as well as manufacturing highlights the emphasis some of her colleagues have also placed in recent speeches on the balance of evidence.

Sir Alan Budd said in a speech last Friday that many City commentators had viewed the evidence in a one-sided way, focusing on the slowdown in manufacturing rather than the inflationary dangers posed by bigger private- sector pay rises. The MPC is also wary about the likely impact of the introduction of the minimum wage next year on earnings growth.

DeAnne Julius on the service economy, page 19