Starting in the autumn of 2008 and continuing into the early months of 2009, demand – in the UK and globally – weakened very sharply. Consumers and firms held back spending plans in the wake of the massive negative confidence shocks associated with the events surrounding the collapse of Lehman Brothers and the knock-on effects on the rest of the financial system. Along with the rest of the MPC, I strongly supported the decision to reduce interest rates from 5% to 0.5% between October 2008 and March 2009, and to inject extra money into the economy through Quantitative Easing. The bulk of this money injection £ of the total £ was agreed by the time of the August 2009 Inflation Report, which was published just under a year ago. Though that Report looked forward to a recovery in the economy, very little economic data available at that time pointed in that direction. Rather, the economic data last summer were telling us how sharply the economy had contracted in late 2008 and the first half of 2009 both at home and abroad, and how sharply unemployment had risen as a result. A strong theme underpinning the analysis of both the May and August Inflation Reports last year was that UK inflation was expected to be pushed significantly below target by a large margin of spare capacity.
5 The evidence from the Bank of England’s Agents and recent employment surveys is that the labour market in the UK has stabilised and that labour demand in the private sector may have already started to pick up. Companies also seem to have adjusted quickly to a lower level of demand and activity in the recession, and the most recent surveys do not point to an unusually large margin of spare capacity remaining within firms. For example, the latest CBI survey shows 62% of manufacturers reporting some spare capacity – which is virtually in line with the average for the decade before the financial crisis. 6 The evidence on wages and prices is also consistent with the view that spare capacity is not exerting as much downward pressure on inflation as the MPC expected last summer. In the manufacturing sector, underlying wage growth is back up to the 4–5% level already, though is more subdued in the services sector. And after quite widespread pay freezes last year, the latest pay settlements data from Income Data Services show that the most popular range for pay settlements is currently 2–3%, which is where four out of ten pay settlements are now being struck. If the recovery continues and headline inflation remains relatively high, there may be a further upward drift in pay growth in the private sector, offsetting some of the downward pressure on wage growth from the public sector.