Figure 3: UK 5 year five year inflation swap rates have historically been stable…  5  A number of investors use the underlying swap products to meet regulatory hedging requirements, and shifts in their demand can have a material impact on pricing. 11  All speeches are available online at www.bankofengland.co.uk/news/speeches and @BoE_PressOffice  11  Figure 4: … including during the Covid pandemic  Looking ahead As I’ve already stressed, the MPC’s November forward guidance said that we did not intend to tighten monetary policy at least until there was clear evidence that significant progress was being made in eliminating spare capacity and achieving the 2% inflation target sustainably. That guidance still applies today: we have repeated it in the Minutes of each subsequent meeting, including our most recent one in June. I have thought since we first introduced it in November that our guidance would become more salient as the economy recovered, and that is being borne out by current developments. Inflation is already overshooting the target, and it is less clear, at least to me, that there remains a degree of spare capacity. But as the MPC’s guidance makes clear what matters is whether we expect inflation to return to target sustainably. At the same time, when we launched our ongoing £ QE programme in November it was explicitly for risk management reasons.
There is nothing to suggest that the rate of and pressure from these changes will ease off in the years ahead. On the contrary, international integration seems to be becoming more intense. The establishment of EMU means that this trend will accelerate. EMU affects the financial system The introduction of the single currency will affect the financial system in various ways. The most obvious change is the end to exchange transactions between the national currencies in the euro area. This also means an end to forwards and swaps in these currencies. By itself, this will leave its mark on the earnings of European banks. The coming of the euro will also affect financial activities in Europe more profoundly and may necessitate a number of changes. The euro area will constitute a larger and more uniform market with a population of about two hundred million. This market, moreover, is likely to attract investors from other European countries and other parts of the world. Via growing competition, a larger market normally leads to lower costs and increased liquidity. With more investors and the elimination of exchange risks, it will cost less to diversify savings by placing them in more countries. In other words, savers in one country will transfer some of their assets to other countries. This process has, in fact, already begun. Briefly, then, all at once there will be a much larger and much more liquid European capital market that in time may resemble the US market in size and nature.