In the labour markets, reforms which have made possible greater labour flexibility, and competitive pressures which have stimulated firms to adapt more quickly to changes in their business environment, may underlie the more benign performance of real earnings growth. More widely, the greater stability the economy has enjoyed in recent years from the medium-term framework that governs both fiscal and monetary decisions may, by stabilising inflationary expectations at a low level, have made it less attractive, and more risky, to try to raise prices even when demand is strong, and may also have enabled industry and commerce to plan their business activities on a sounder and more forward-looking basis. There is plenty of evidence that all these factors are, in varying degrees, at work in the UK; and they offer the prospect of genuine improvements in the functioning of the economy. But the question is - on what scale, and are the improvements temporary or here to stay? We take considerable care to try to factor these developments into our decisions on interest rates, but the difficult judgment is to assess how much faster the economy can grow as a result without jeopardising our inflation target. My own view is that supply-side improvements are delivering benefits, but the process is a gradual and progressive one, rather than any sudden leap forward. Miracles in the real world are pedestrian affairs, arriving step by step.
An improvement in the balance of the economy was also achieved last year from another source - a welcome easing in the strength of sterling which itself had been a reflection of the persistent weakness of the euro. As the euro has recovered somewhat over the past year, and sterling has moved back from its peak levels, this has, at least in degree, eased some of the pressures faced by exporters and by businesses most exposed to import competition. The result is a better balance between the externally-exposed sectors of the economy and domestically-orientated businesses, between manufacturing and services, and between different regions of the country. Two other clouds that had threatened the sustainability of our growth performance also receded somewhat last year. One was the impact throughout the economy emanating from the steep rise in oil prices, which abated as oil prices fell back from their peak levels. The other concern was that share prices had risen to levels which many felt were not sustainable in terms of reasonable expectations of future corporate profits. The fall in share prices during last year was not a comfortable experience falling asset prices rarely are - but it removed some of the sense of unreality.