Bank of England — Monetary Policy Report (UK, 2023)

Bank of England Monetary Policy Report Monetary Policy Committee August 2023 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   Ben Broadbent   Jon Cunliffe   Swati Dhingra   Megan Greene   Jonathan Haskel   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 www.bankofengland.co.uk/monetary-policy- report/2023/august-2023.   Bank of England 2023 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 Report 2: Current economic conditions 2.1: Global economy and financial markets 2.2: Interest rates facing households and firms 2.3: The impact of interest rates on activity 2.4: UK activity 2.5: The labour market and wage growth 2.6: Inflation 2.7: Inflation expectations Box C: Agents  update on business conditions Box D: Key messages from external meetings on food price inflation 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 27 33 35 37 41 45 50 52 59 67 71 75 78 80 89 Bank of England Page 3 Monetary Policy Summary The Bank of England s Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment. At its meeting ending on 2 August 2023, the MPC voted by a majority of 6 3 to increase Bank Rate by 0.25 percentage points, to 5.25%. Two members preferred to increase Bank Rate by 0.5 percentage points, to 5.5%, and one member preferred to maintain Bank Rate at 5%. The Committee s updated projections for activity and inflation are set out in the accompanying August Monetary Policy Report. These are conditioned on a market- implied path for Bank Rate that rises to a peak of just over 6% and averages just under 5 % over the three-year forecast period, compared with an average of just over 4% for the equivalent period at the time of the May Report. The sterling effective exchange rate is around 4% higher than in the May Report. Underlying quarterly GDP growth has been around 0.2% during the first half of this year. Bank staff expect a similar growth rate in the near term, reflecting more resilient household income and retail sales volumes, and most business surveys over recent months. Some more recent indicators show signs of weakening, however, including the July S&P Global/CIPS UK composite PMI. The labour market remains tight but there are some indications that it is loosening. The LFS unemployment rate rose to 4.0% in the three months to May, somewhat higher than expected in the May Report, and the vacancies to unemployment ratio has continued to fall, although the latter still remains above historical averages. Annual private sector regular pay growth increased to 7.7% in the three months to May, materially above expectations at the time of the May Report, and three-month on three- month growth in this measure of pay has picked up further. Earnings growth is nevertheless expected to decline in coming quarters, to around 6% by the end of this year, although there is uncertainty around this near-term outlook. Twelve-month CPI inflation fell from 8.7% in May to 7.9% in June, lower than expected at the time of the Committee s previous meeting. Within this, core goods and services CPI inflation were both lower than expected, although the downside news in the latter, which is more likely to be informative about persistent inflationary pressures, was much smaller. Compared to the May Report projections, June CPI inflation was in line with expectations. Bank of England Page 4 CPI inflation remains well above the 2% target. It is expected to fall significantly further, to around 5% by the end of the year, accounted for by lower energy, and to a lesser degree, food and core goods price inflation. Services price inflation, however, is projected to remain elevated at close to its current rate in the near term. In the MPC s August most likely, or modal, projection conditioned on market interest rates, CPI inflation returns to the 2% target by 2025 Q2. It then falls below the target in the medium term, as an increasing degree of economic slack reduces domestic inflationary pressures, alongside declining external cost pressures. The Committee has decided in this forecast to bring some of the upside risks to inflation from persistence into its modal projection, pushing up on this inflation projection in the medium term relative to the May Report. The Committee continues to judge that risks around the modal inflation forecast are skewed to the upside, albeit by less than in May, reflecting the possibility that the second- round effects of external cost shocks on inflation in wages and domestic prices take longer to unwind than they did to emerge. Mean CPI inflation, which incorporates these risks, is 2.0% and 1.9% at the two and three-year horizons respectively. The MPC s remit is clear that the inflation target applies at all times, reflecting the primacy of price stability in the UK monetary policy framework. The framework recognises that there will be occasions when inflation will depart from the target as a result of shocks and disturbances. Monetary policy will ensure that CPI inflation returns to the 2% target sustainably in the medium term. Recent data outturns have been mixed. However, some key indicators, notably wage growth, suggest that some of the risks from more persistent inflationary pressures may have begun to crystallise. At this meeting, the Committee voted to increase Bank Rate by 0.25 percentage points, to 5.25%. Given the significant increase in Bank Rate since the start of this tightening cycle, the current monetary policy stance is restrictive. The MPC will continue to monitor closely indications of persistent inflationary pressures and resilience in the economy as a whole, including the tightness of labour market conditions and the behaviour of wage growth and services price inflation. If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required. The MPC will ensure that Bank Rate is sufficiently restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term, in line with its remit. Bank of England Page 5 1: The economic outlook CPI inflation remains well above the 2% target, having fallen back to 7.9% in June in line with expectations in the May Monetary Policy Report. Both services and core goods CPI inflation have been stronger than expected, although news in the latter is in general less likely to imply persistent inflationary pressures. The Committee expects CPI inflation to continue to fall, to around 5% by the end of the year, owing to lower energy, and to a lesser degree, food and core goods price inflation. Annual private sector regular pay growth has increased further, to 7.7% in the three months to May, materially above expectations in the May Report. The near-term outlook for regular pay growth is uncertain, but the MPC expects it to decline to around 6% by the end of this year. Sharp increases in energy, food and other import prices over the past two years have had second-round effects on domestic prices and wages. These second- round effects are likely to take longer to unwind than they did to emerge, and the MPC has placed weight in its recent forecasts on the risk that they might persist for longer. The Committee now judges that some of this risk may have begun to crystallise. As a result, the MPC has decided to bring some of the upside risks to inflation from persistence into its most likely, or modal, projection. In this forecast, and assuming Bank Rate follows the path implied by finan