Operation of monetary policy

This article covers the period from July to September.

During the third quarter the rate at which inflation was declining became evident. This was seen in the slower growth of retail prices, as well as in underlying earnings and pay settlements, and was reflected in falling inflation expectations among producers and consumers and in financial markets. In addition, sterling remained firm, well within its ERM bands, and rose modestly in effective terms over the quarter. Against this background, a further moderate easing of policy was possible, with two ½% cuts in base rates effected in July and September. As sterling's overall steadiness in the ERM indicated, these moves were accepted by the markets as being fully consistent with the continuing stance of easing policy only as inflationary pressures abate.

A fall in inflation expectations was evident in gilt yields, which fell at all maturities, with long yields down from above 10% at the beginning of July to below 9.5% by the end of the quarter. Moreover, the differential between conventional and index-linked yields narrowed over the quarter, possibly further indicating an improvement in inflation expectations. The rally in the gilt-edged market also enabled substantial official sales of stock to be made, worth some £4.7 billion over the quarter.

Operation of monetary policy