Bank of England — Monetary Policy Report (UK, 2024)

Bank of England Monetary Policy Report Monetary Policy Committee August 2024 Monetary policy at the Bank of England The objectives of monetary policy The Bank s Monetary Policy Committee (MPC) sets monetary policy to keep inflation low and stable, which supports growth and jobs. Subject to maintaining price stability, the MPC is also required to support the Government s economic policy. The Government has set the MPC a target for the 12-month increase in the Consumer Prices Index of 2%. The 2% inflation target is symmetric and applies at all times. The MPC s remit recognises, however, that the actual inflation rate will depart from its target as a result of shocks and disturbances, and that attempts to keep inflation at target in these circumstances may cause undesirable volatility in output. In exceptional circumstances, the appropriate horizon for returning inflation to target can vary. The MPC will communicate how and when it intends to return inflation to the target. The instruments of monetary policy The MPC currently uses two main monetary policy tools. First, we set the interest rate that banks and building societies earn on deposits, or  reserves , placed with the Bank of England   this is Bank Rate. Second, we can buy government and corporate bonds, financed by the issuance of central bank reserves   this is asset purchases or quantitative easing. The Monetary Policy Report The MPC is committed to clear, transparent communication. The Monetary Policy Report (MPR) is a key part of that. It allows the MPC to share its thinking and explain the reasons for its decisions. The Report is produced quarterly by Bank staff under the guidance of the members of the MPC. This Report has been prepared and published by the Bank of England in accordance with section 18 of the Bank of England Act 1998. Bank of England Page 1 The Monetary Policy Committee   Andrew Bailey, Chair   Sarah Breeden   Swati Dhingra   Megan Greene   Jonathan Haskel   Clare Lombardelli   Catherine L Mann   Huw Pill   Dave Ramsden PowerPoint  versions of the Monetary Policy Report charts and Excel spreadsheets of the data underlying most of them are available at http://www.bankofengland.co.uk/monetary- policy-report/2024/august-2024.   Bank of England 2024 ISSN 2633-7819 Bank of England Page 2 Contents Monetary Policy Summary 1: The economic outlook 1.1: The conditioning assumptions underlying the MPC s projections 1.2: Key judgements and risks Box A: Reviewing the process of quantitative tightening Box B: Monetary policy since the May 2024 Report 2: Current economic conditions 2.1: Global economy and financial markets 2.2: Domestic credit conditions 2.3: Domestic activity and the labour market 2.4: Inflation and wages Box C: Monitoring the impact of recent monetary policy tightening on the economy Box D: Agents  update on business conditions Annex 1: Other forecasters  expectations Annex 2: How has the economy evolved recently relative to the MPC s projections? Glossary and other information 4 6 8 9 22 28 30 32 37 42 50 61 71 76 78 88 Bank of England Page 3 Monetary Policy Summary The Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment. The MPC adopts a medium-term and forward- looking approach to determine the monetary stance required to achieve the inflation target sustainably. At its meeting ending on 31 July 2024, the MPC voted by a majority of 5 4 to reduce Bank Rate by 0.25 percentage points, to 5%. Four members preferred to maintain Bank Rate at 5.25%. The Committee has published an updated set of projections for activity and inflation in the accompanying August Monetary Policy Report. Twelve-month CPI inflation was at the MPC s 2% target in both May and June. CPI inflation is expected to increase to around 2 % in the second half of this year, as declines in energy prices last year fall out of the annual comparison, revealing more clearly the prevailing persistence of domestic inflationary pressures. Private sector regular average weekly earnings growth has fallen to 5.6% in the three months to May, and services consumer price inflation has declined to 5.7% in June. GDP has picked up quite sharply so far this year, but underlying momentum appears weaker. The Committee s framework for assessing the medium-term outlook for inflation distinguishes between first and second-round effects. The MPC has been focused on second-round effects that capture more persistent inflationary pressures. The Committee continues to monitor the accumulation of evidence from a broad range of indicators. The Committee expects the fall in headline inflation, and normalisation in many indicators of inflation expectations, to continue to feed through to weaker pay and price-setting dynamics. A margin of slack should emerge in the economy as GDP falls below potential and the labour market eases further. Domestic inflationary persistence is expected to fade away over the next few years, owing to the restrictive stance of monetary policy. However, there is a risk that inflationary pressures from second-round effects will prove more enduring in the medium term. A stronger-than-expected path for demand, and structural factors such as a higher equilibrium rate of unemployment, could affect domestic wage and price-setting more persistently. Furthermore, the degree of restrictiveness of monetary policy could be less than embodied in the Committee s current assessment. In balancing these considerations, at this meeting, the Committee voted to reduce Bank Rate to 5%. It is now appropriate to reduce slightly the degree of policy restrictiveness. The impact from past external shocks has abated and there has been some progress in moderating risks of persistence in inflation. Although GDP has been stronger than expected, the restrictive stance of monetary policy continues to weigh on activity in the real economy, leading to a looser labour market and bearing down on inflationary pressures. Bank of England Page 4 Monetary policy will need to continue to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term have dissipated further. The Committee continues to monitor closely the risks of inflation persistence and will decide the appropriate degree of monetary policy restrictiveness at each meeting. Bank of England Page 5 1: The economic outlook Twelve-month CPI inflation was at the MPC s 2% target in May and June, close to the projection in the May Monetary Policy Report. GDP has picked up quite sharply so far this year, but underlying momentum appears weaker. Four-quarter GDP growth is expected to fall back a little next year in the Committee s modal or most likely projection, but then increase again over the remainder of the forecast period, to around 1 % (Key judgement 1). That pickup in part reflects the fading negative impact on growth from past increases in Bank Rate and the downward-sloping market-implied path of forward interest rates, which begin to boost growth towards the end of the period. The risks around the modal projection for GDP growth are skewed slightly to the upside over the first two years of the forecast period. In the modal projection, aggregate demand and supply are judged to be broadly in balance currently, but a margin of economic slack is projected to emerge during 2025 and to remain thereafter, reflecting the continued restrictive stance of monetary policy (Key judgement 2). Unemployment is expected to rise somewhat. The risks around the modal output gap projection are judged to be skewed to the upside in part reflecting the possibility of a higher medium-term equilibrium rate of unemployment pushing down on supply relative to demand. CPI inflation is expected to increase to around 2 % in the second half of this year as declines in energy prices last year fall out of the annual comparison, revealing more clearly the prevailing persistence of domestic inflationary pressures (Chart 1.1). The Committee continues to expect second-round effects in domestic prices and wages to take longer to unwind than they did to emerge (Key judgement 3). There remains considerable uncertainty around the calibration of this judgement and a range of views among MPC members about the extent to which persistent pressures prove more enduring or continue to unwind as external cost pressures and inflation expectations have normalised. In the MPC s modal projection conditioned on the market-implied path of interest rates, CPI inflation falls back to 1.7% in two years  time and to 1.5% in three years, reflecting the continued restrictive stance of monetary policy and the emergence of a margin of slack in the economy. The risks around the modal CPI projection are skewed somewhat to the upside throughout the forecast period, reflecting more persistence in domestic wage and price- setting. That could reflect more structural factors such as the possibility of a higher equilibrium rate of unemployment. Mean CPI inflation is 2.0% and 1.8% at the two and three-year horizons respectively. Bank of England Page 6 Table 1.A: Forecast summary (a) (b) 2024 Q3 2025 Q3 2026 Q3 2027 Q3 GDP (c) 1.5 (0.5) 0.8 (0.9) 1.4 (1.3) Modal CPI inflation (d) 2.3 (2.2) 2.4 (2.5) 1.7 (1.8) Mean CPI inflation (d) 2.3 (2.4) 2.5 (2.6) 2.0 (1.8) Unemployment rate (e) 4.4 (4.3) 4.6 (4.7) 4.8 (4.9) Excess supply/Excess demand (f) 0 (- ) -1 (-1) -1  (-1 ) Bank Rate (g) 5.1 (5.0) 4.2 (4.4) 3.8 (3.9) 1.7 1.5 1.8 4.6 -  3.5 (a) Figures in parentheses show the corresponding projections in the May 2024 Monetary Policy Report. (b) Unless otherwise stated, the numbers shown in this table are modal projections and are conditioned on the as