In particular, while growth and employment rates have been converging upwards across the euro area, significant gaps still remain in terms of levels. In large parts of the euro area there are still substantial under-utilised resources, reflected in a negative output gap and high unemployment rates. And this is of course crucial for our assessment of the path of inflation – namely, whether we see a sustained adjustment that would warrant a scaling back of our exceptional degree of monetary policy accommodation. Let me remind you that we have established four criteria to confirm a sustained adjustment: first, that headline inflation is on a path to levels below but close to 2% over a meaningful mediumterm horizon; second, that inflation will be durable and stabilise around those levels with sufficient confidence; third that inflation will be self-sustained, meaning it will maintain its trajectory even with diminishing support from monetary policy. And finally, it goes without saying that in each case the relevant metric is euro area inflation not the inflation rates of any individual country. For the first criterion, the assessment does now seem to be improving: our latest projections foresee the path of headline inflation now much closer to the target over 2017–2019. But the inherent uncertainty in the forecasting process needs to be mitigated by cross-checking with other available information on inflation dynamics. Particularly useful here are measures of underlying inflationary pressures, since they can be monitored in real-time and tend to be more informative than headline inflation for medium-term price developments.
The reason that our interest rates remain higher than those in the Eurozone is that, despite the recent slowdown, our economy is operating closer to capacity than theirs. That’s partly why our rate of unemployment is almost half theirs – though the greater structural flexibility of the British economy is even more important in this context. The MPC sets interest rates to achieve the inflation target. We have made it clear by our actions that we are just as vigorous in relaxing policy when the risks to inflation are on the downside as we are in tightening policy when the risks to inflation are on the upside. That’s the best help that we can give through monetary policy. It does not mean that we ignore the external pressures. In assessing the prospects for the overall economy, and for inflation, we take full account of the impact of world demand and of the exchange rate, just as we take full account of all the domestic factors bearing on inflation prospects. When, as now, the external influences are having a powerful disinflationary effect, monetary policy is of course easier, and interest rates lower, than they would otherwise be. That does not – and cannot – mean that we are able to pursue any particular objective with regard to the exchange rate – or that we respond, Pavlov-like, to exchange rate fluctuations.