Essay on Inflation and Monetary Policy Committee

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Publication date: 25 January 2012

MINUTES OF THE

MONETARY POLICY COMMITTEE MEETING
11 AND 12 JANUARY 2012

These are the minutes of the Monetary Policy Committee meeting held on 11 and 12 January 2012.

They are also available on the Internet http://www.bankofengland.co.uk/publications/minutes/mpc/pdf/2012/mpc1201.pdf The Bank of England Act 1998 gives the Bank of England operational responsibility for setting interest rates to meet the Government’s inflation target. Operational decisions are taken by the Bank’s Monetary Policy Committee. The Committee meets on a regular monthly basis and minutes of its meetings are released on the Wednesday of the second week after the meeting takes place. Accordingly, the minutes of the Committee meeting to be held on 8 and 9 February will be published on 22 February 2012.

MINUTES OF THE MONETARY POLICY COMMITTEE MEETING HELD ON 11 AND 12 JANUARY 2012
1 Before turning to its immediate policy decision, the Committee discussed financial market

developments; the international economy; money, credit, demand and output; and supply, costs and prices.

Financial markets

2

While the most recent data from the United States had been a supportive influence on financial

markets over the month, the main events affecting asset prices had continued to be those in the euro area. The three-year long-term repo operation by the ECB on 21 December 2011 had improved market sentiment and a number of banks had been able to issue public unsecured term debt. Major European banks’ issuance in 2012 had already exceeded that in the whole of the second half of 2011. So far it had been the large, more highly rated, banks that had issued, albeit at spreads that had remained elevated. Issuance of secured term debt by banks had also been relatively robust.

3

Banks were reported to have used the long-term repo operation to provide funding for existing

bank balance sheets, potentially reducing pressures to de-lever, rather than to expand balance sheets. It was unclear to what extent banks might increase their purchases of sovereign debt of the vulnerable euro-area countries in future, although two-year Spanish and Italian yields had fallen on the month. A second ECB operation would take place at the end of February.

4

Ten-year German bond yields, which had moved erratically during the latter part of 2011, had

fallen back below 2%. But government bond yields in many other euro-area countries had remained high. Over the month, ten-year spreads to bunds had widened a little for Spain and substantially for Italy. In the United Kingdom, ten-year gilt yields had fallen to new lows of around 2% in late December. Real long-term yields on gilts had been below 0% over recent months and they had accounted for the larger part of the movements in nominal yields during 2011.

5

Short-term interest rates were little changed in the United Kingdom, but had fallen in the euro

area, in part reflecting the ECB’s policy rate reduction in December. The euro effective exchange rate index (ERI) had weakened by around 3½% in the past month. Over the same period, the sterling ERI

2 had appreciated by just over 1%. The skews in options prices continued to imply a balance of risks towards the euro depreciating relative to the US dollar and sterling.

6

Equity markets internationally had fallen before the ECB operation but had rallied subsequently.

Over the month as a whole, the FTSE All-Share index was up slightly. It was notable that equity prices had recovered significantly since their very sharp falls in the summer, despite the subsequent downgrades to economic forecasts.

7

Non-financial and financial corporate bond spreads had changed little on the month. 2011 had

ended with relatively high gross UK non-financial corporate bond issuance. But new issuance premia had risen during the autumn and liquidity in the secondary market appeared to have been poor. Although
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