17 The annual rate of inflation in manufacturers’ input prices had fallen further in November and
output price inflation had been broadly stable. CIPS/RBS survey measures for December had
indicated that input price inflation had continued to diminish in both manufacturing and services. But
the survey balances for output price inflation in services had picked up a little in December, in contrast
to the manufacturing sector, perhaps reflecting the relative growth of demand.
18 In line with pre-release arrangements, an advance estimate of CPI inflation of 3.0% in December
had been provided to the Governor ahead of publication. That compared with 2.7% in November.
Part of the rise in the inflation rate could be explained by petrol prices having risen this December
while having fallen in December 2005. Analysis of the data had to wait until publication but, since the
summer of 2006, the Committee had been projecting a sharp pickup in CPI inflation during the autumn
and winter months before falling back towards the target in 2007 as energy and import price inflation
moderated. Although that pickup had occurred, it appeared that there had been some news:
lower-than-expected contributions, for example, from energy and university tuition fees, had been
offset by a broader range of price increases, especially for food.
5
The immediate policy decision
19 The world and domestic economies had evolved largely as the Committee had projected in the
August and November Inflation Reports but the recent data had suggested that the balance of risks
might have shifted. In particular, the risk of a greater slowdown in the United States, arising from a
weakening housing market, had diminished. Overall, the world economy appeared to be robust and
the downside risks appeared to have diminished somewhat.
20 There had been a further significant fall in the spot price of oil, which was probably explained by
unusually mild weather and high stock levels. If sustained, the lower oil price would help to contain
inflationary pressures in oil-consuming countries, as well as supporting demand growth going forward.
21 There had been little news about the path of domestic output growth. The level of GDP had been
revised up a little and, within that, the level of consumption was estimated to be a little lower and net
trade and business investment a little higher. The Committee placed little weight on the early
estimates of the expenditure components.
22 In aggregate, the data were broadly consistent with the November Inflation Report projections.
But the CIPS/RBS business surveys and the Agents’ reports both suggested some upside risks to shortterm
growth. And the retail sales indicators for the fourth quarter had been robust, perhaps suggesting
less downside risk of a further slowing in consumption growth. Broad money and credit growth
continued to be very strong and asset prices were buoyant across the board.
23 The Committee considered whether the high level of asset prices should be a concern for
monetary policy. There could be some risk arising from a direct pass through of higher asset prices to
household wealth and hence into the demand for goods and services. There could also be some risk of
a sharp reversal in asset prices although, to the extent that they were reflecting ongoing fundamental
changes in the global economy such as growth in China, it was perhaps unlikely that they would
unwind soon. Some members argued that the strength of money, credit and asset prices could
influence the nominal side of the economy, for example, by influencing inflation expectations. That
strength could be an indicator of incipient inflationary pressures.
6
24 The labour market had developed largely as the Committee had expected. The quantity
indicators showed a broadly stable picture and there was little evidence yet of any change in wage
settlements or pay growth. The Committee noted the high median pay settlement recorded by IDS, but
it was too early to tell what would happen with January settlements overall. It was likely that there
was some continuing slack in the labour market, but the increase in retail price inflation posed an
upside risk to pay growth.
25 The available survey evidence on spare capacity within firms had suggested that this had continued
to tighten. The Agents had reported an increased readiness of retailers to push through price increases,
particularly for foodstuffs. Investment growth had been strengthening, perhaps encouraged by the
increased supply of labour as well as by robust demand, but it would take some time for new fixed
investment to relieve capacity constraints.
26 In its August and November Inflation Reports, the Committee had anticipated a short-run spike
in CPI inflation, falling back during 2007. While the outturn for CPI inflation had been close to the
Committee’s projections during the autumn, some members thought that there seemed to be more
underlying inflationary pressure in the short run than previously expected. Looking back over 2006 as
a whole, the outturn for GDP growth looked set to be very close to that expected in the February 2006
Inflation Report, but CPI inflation was materially higher than projected at that time. Some of that
surprise could be accounted for by the effects of unexpected energy price increases. Another
unexpected increase had come from the rise in fuel duty. One possible explanation for the extent of
upwards pressure on inflation was that profit margins might have been initially squeezed by higher
energy prices in the face of some weakness in demand in 2005. As demand growth had recovered
through 2006, firms might have sought to raise profits by increasing prices.
27 Although the Committee had received advance notification of the December CPI release on the
morning of its meeting, it had not had been able to analyse in detail the reasons for the sharp increase
in inflation. The central projection in the November Inflation Report had been for CPI inflation to fall
back towards the target during 2007, as energy and import price inflation moderated. Some members
thought that the balance of risks to this central case had now shifted to the upside. A risk for the
medium-term was the possibility of dislodging inflation expectations. With RPI inflation likely to be
nearly 4½% in December, the Committee noted that it was important that wage negotiators did not
accommodate what should prove to be a temporary spike in inflation.
7
28 On the policy decision, the Committee noted that an immediate change in Bank Rate would
clearly be a surprise to financial markets. Market prices indicated that a rate rise of 25 basis points
was expected, but not until February. This probably reflected the fact that the Committee had not
changed interest rates other than in an Inflation Report month for some 2½ years.
29 The Committee agreed that, although the news on the month had been broadly in line with its
central projections, the balance of risks to the outlook for inflation had shifted upwards. There was a
range of views amongst the Committee over the new balance of risks and over whether the news had
been sufficient to warrant an increase in Bank Rate this month or whether it would be better to wait
and judge the news in the context of the Committee’s February Inflation Report.