These reports showed fan charts in which inflation was much more likely to be below the target than above it throughout the two to three year horizon over which the Bank produces its forecasts. The central projection in both Inflation Reports we produced last summer suggested inflation would fall to around 1% or just above in the first half of 2011 and to struggle to return to the target after that. This was the economic backdrop against which I and other members of the MPC took the key decisions to put in place the monetary policy settings which we currently have in place today: sharp falls in demand and rises in unemployment; great uncertainty about recovery prospects; and a general expectation of persistent below target inflation. The Bank was not alone in its prognosis – this was the general view of the forecasting consensus last summer. A year on, however, the economic situation has changed. There are still many uncertainties about future economic prospects. But there are four features of the current position of the economy which are now very different from the situation we faced last summer – the world economy has bounced back, the UK economy is also recovering, the margin of spare capacity does not appear to be as large as we had expected a year ago, and inflation has run above target rather than falling below it. Before moving on to talk about monetary policy, I will briefly discuss these four factors in turn.
One of the key reasons for embarking on the policy of Quantitative Easing was to reverse this downward shift in money spending, which would have pulled down inflation sharply if it had continued. As Chart 3 shows, this trend in nominal demand has indeed reversed. GDP and domestic demand measured in money terms rose at an annualised rate of around 5.5% in the last 3 quarters for which we have data, and total final expenditure – which also includes export demand – grew by nearly 7%. On all the three main measures of nominal demand, growth is now back to or above the pre-recession average rate. This is a rapid turnaround from the sharp falls seen in late 2008 and early 2009. 4  BIS Review 99/2010  Chart 3: UK Nominal Demand Growth Percent 8  1997 Q1 - 2007 Q4 average  7  2009 Q3 - 2010 Q1 average (annualised)  6 5 4 3 2 1 0 GDP  Domestic Demand  Total Final Expenditure  Note: Domestic demand defined as public and private consumption and investment spending Source: Office for National Statistics  Business surveys are also showing a generally positive picture. Chart 4 shows the latest responses from the British Chambers of Commerce’s survey – which points to a particularly strong rebound in manufacturing, with a slower recovery in the services sector. But both manufacturing and services are showing a return to growth, alongside positive expectations that the recovery in demand will continue.