My authorities value their annual consultation with staff and will carefully consider their comments. There is a broad level of agreement on most aspects of economic policy.

The economic fundamentals in the UK remain sound. Growth was at trend (2.7 percent) in 2006 and is forecast in the 2006 Pre–Budget Report at 2 ¾ - 3 ¼ percent in 2007, and 2 ½ - 3 percent in 2008. CPI inflation rose to 3 per cent at the end of the year, reflecting higher energy and import prices, but is expected to return to its 2 percent target by the end of 2007. Employment remains at record levels of 74.5 percent. As staff report, there are risks, both upside and downside: my authorities remain vigilant to these and agree with staff on the need for cautious macroeconomic polices, to which they are fully committed.

My authorities will continue to set policy on the basis of the policy framework established in 1997, based on the principles of transparency, responsibility and accountability.

• fiscal policy set according to two fiscal rules:

  • The golden rule – over the cycle, the Government will borrow only to invest and not to fund current spending;

  • The sustainable investment rule – over the cycle, public sector net debt will be held at a stable and prudent level, defined as 40 percent of GDP or less;

• Monetary policy set by the Bank of England’s Monetary Policy Committee to meet a symmetric inflation target.

My authorities agree with staff that the macroeconomic policy framework has served the UK well, guiding policies and anchoring expectations to deliver long–term stability.

My authorities concur with staff that monetary policy is well–positioned, but that continued vigilance is needed to ensure that inflation returns to target. The current monetary policy framework gives the Monetary Policy Committee flexibility to adapt its analysis in the light of events and new data, while maintaining a focus on the inflation target and thus anchoring inflation expectations. The present policy framework should have the capacity to withstand more turbulent times, should they materialise.

Fiscal policy will, as usual, be set in the budget. My authorities’ plans will reduce the deficit over the medium term. The latest official projections show a gradual reduction to 1.3 percent of GDP, with an average annual surplus on the current budget over the cycle, and net debt stabilising at 38.5 per cent. My authorities are therefore meeting the fiscal rules. As staff note, my authorities have already taken a number of steps to restrain spending growth and deliver medium–term fiscal consolidation by committing to, for the period 2008–09 to 20 10–11:

• a series of early departmental spending settlements at or below the rate of inflation;

• cross–government value for money savings of at least 3 percent per annum;

• a 5 per cent annual real reduction in administration budgets across departments; and

• ensuring public sector pay settlements are affordable and consistent with the 2 percent inflation target.

Full departmental spending allocations for this period will be announced later this year following the conclusion of the Comprehensive Spending Review.

As staff note, the fiscal framework has performed well, constraining discretion and protecting public investment, and allowing fiscal policy to respond to shocks such as the global slowdown in 2001-2002. With a decade of experience the framework is very well established, and my authorities believe that stability in the framework has strengthened its credibility. Defining the rules over the cycle has been central to this. As staff note, the authorities have broadened the scope of independent audit by the National Audit Office of key budget assumptions. Last year the National Audit Office approved the methodology for dating the economic cycle; this year they are auditing five assumptions, including tax compliance, the VAT gap, and tobacco receipts.

On the financial sector, there is, as noted in the staff report, a high degree of convergence between the views of staff and the authorities. The Bank of England’s relaunched Financial Stability Report provides a forward–looking analysis of the systemic risks to the UK economy as well as efforts to mitigate these risks. The authorities are working with the private sector to improve stress testing, including understanding the links between firms. International efforts to coordinate crisis prevention and management are vital and the UK is working towards improving these mechanisms.