Budget: 2013 Growth Forecast Is Cut In Half

Osborne's Letter To B of E Governor

Updated: 1:44pm UK, Wednesday 20 March 2013

Chancellor George Osborne has reaffirmed the 2% inflation target in a letter to the Governor of the Bank of England.

REMIT FOR THE MONETARY POLICY COMMITTEE

The Bank of England Act (1998) requires that I specify what price stability is taken to consist of and the Government's economic policy objectives at least once in every period of 12 months beginning on the anniversary of the day the Act came into force.

I hereby re-confirm the inflation target as 2 per cent as measured by the 12-month increase in the Consumer Prices Index (CPI). The inflation target of 2% applies at all times.

This reflects the primacy of price stability and the inflation target in the UK monetary policy framework.

In accordance with the Act, I also confirm that the economic policy objective of Her Majesty's Government is to achieve strong, sustainable and balanced growth that is more evenly shared across the country and between industries.

The Government's commitment to medium-term price stability remains absolute. It represents an essential pre-requisite for economic prosperity.

The remit recognises that inflation will on occasion depart from its target as a result of shocks and disturbances. Attempts to keep inflation at the target in these circumstances may cause undesirable volatility in output. This reflects the short-term trade-offs that must be made between inflation and output variability in setting monetary policy. It therefore allows for a balanced approach to the objectives set out in the remit, while retaining the primacy of price stability and the inflation target.

In recent years, the economy has been hit by a series of shocks, some of which have been exceptionally large and with persistent effects. For example, the Office for Budget Responsibility and the International Monetary Fund forecast output in the UK to remain below its potential level for at least five years. Large shocks with persistent effects pose challenges for the setting and communicating of monetary policy and involve significant trade-offs. The remit clarifies the Government's expectations of the Committee in terms of the judgements it must make in setting and communicating policy in such exceptional circumstances.

As the Committee explained in its statement alongside its decision on 7 February 2013, CPI inflation is likely to rise further in the near term and may remain above the 2% target for the next two years, in part reflecting a persistent inflationary impact from both administered and regulated prices and the recent decline in sterling. The Committee judged that as long as cost and price pressures remained consistent with inflation returning to the target in the medium

term, it was appropriate to look through the temporary, albeit protracted, period of above-target inflation.

I confirm that the Committee's interpretation of the flexibilities provided by the remit is correct, and that these flexibilities are conditional on the Committee's judgement that the risks to meeting the 2% inflation target in the medium term remain balanced. The Committee should remain vigilant to those risks to ensure that medium-term inflation expectations remain anchored. This represents an appropriately balanced approach to the Committee's objectives, while retaining the primacy of medium-term price stability and the inflation target.

Transparency plays an important role in communicating the trade-offs inherent in setting monetary policy. I welcome the Bank of England's response to the independent Stockton Review into the Monetary Policy Committee's forecasting capability, which was published this month.

Over the past year, reflecting the exceptional challenge facing monetary policy makers, there has been ongoing innovation by central banks around the world. The Bank of England, with the Treasury, has launched the Funding for Lending Scheme; the European Central Bank has introduced Outright Monetary Transactions; the US Federal Reserve has developed its forward guidance such that it is currently using state-contingent intermediate thresholds to influence expectations. The Committee has discussed a range of instruments, communicating that discussion through its minutes and the speeches of Committee members.

Monetary activism has a vital role to play in the Government's economic strategy as the Government delivers on its commitment to fiscal consolidation. Given the ongoing exceptional challenges facing the UK economy, it is possible the Committee may judge it necessary to deploy new unconventional policy instruments or approaches in future, including some of those deployed by other central banks in recent years. The remit clarifies that the development of new unconventional instruments should include consideration with Government of appropriate governance and accountability arrangements. It also requests that the Committee provide in its August 2013 Inflation Report an assessment of the merits of intermediate thresholds. I will respond to the general approach outlined by the Committee in its August Inflation Report confirming whether it is consistent with the Monetary Policy Committee's remit.

The new Financial Policy Committee will be established on a statutory basis this April. As a result the remit clarifies how the two committees should interact, and states that the Monetary Policy Committee should have regard to the policy actions of the Financial Policy Committee. I will recommend that the Financial Policy Committee mirrors this.

In setting this remit, the Government has reviewed the monetary policy framework in historical and international context, and the operation of monetary policy in a number of economies in recent years. That review is being published alongside the Budget. It provides further background on the changes that have been made in this remit and the absolute commitment to medium-term price stability that remains at its core. To ensure the UK's monetary policy framework remains at the forefront of international best practice, the Government will undertake a further review before the end of 2019.

A copy of the remit is attached.

Finally, I also confirm that the Asset Purchase Facility, created on 29 January 2009, will remain in place for the financial year 2013-14.

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