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

Bank of England Monetary Policy Report Monetary Policy Committee May 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. Page 1Bank of England The Monetary Policy Committee   Andrew Bailey, Chair   Ben Broadbent   Jon Cunliffe   Swati Dhingra   Jonathan Haskel   Catherine L Mann   Huw Pill   Dave Ramsden   Silvana Tenreyro 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/2023/may-2023.   Bank of England 2023 ISSN 2633-7819 Page 2Bank of England 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: Monetary policy since the February 2023 Report 2: Current economic conditions 2.1: Global economy and financial markets 2.2: Domestic credit conditions 2.3: Demand, output and the labour market 2.4: Prices Box B: The cash-flow channel of monetary policy Box C: Agents  update on business conditions 3: In focus   The outlook for inflation 3.1: Why has inflation been above target? 3.2: How have some of the indicators of inflation persistence been evolving? 3.3: The MPC s forecast for inflation Annex: Other forecasters  expectations Glossary and other information 4 7 8 12 32 34 36 42 45 54 59 70 74 74 79 87 88 90 Page 3Bank of England 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 10 May 2023, the MPC voted by a majority of 7 2 to increase Bank Rate by 0.25 percentage points, to 4.5%. Two members preferred to maintain Bank Rate at 4.25%. The Committee s updated projections for activity and inflation are set out in the accompanying May Monetary Policy Report. They are conditioned on a market-implied path for Bank Rate that peaks at around 4 % in 2023 Q4 before ending the forecast period at just over 3 %. There has been upside news to the near-term outlook for global activity, with UK-weighted world GDP now expected to grow at a moderate pace throughout the forecast period. Risks remain but, absent a further shock, there is likely to be only a small impact on GDP from the tightening of credit conditions related to recent global banking sector developments. Headline inflation has been falling in the United States and euro area, although core inflation measures remain elevated. UK GDP is expected to be flat over the first half of this year, although underlying output, excluding the estimated impact of strikes and an extra bank holiday, is projected to grow modestly. Economic activity has been less weak than expected in February, and the Committee now judges that the path of demand is likely to be materially stronger than expected in the February Report, albeit still subdued by historical standards. The improved outlook reflects stronger global growth, lower energy prices, the fiscal support in the Spring Budget, and the possibility that a tight labour market leads to lower precautionary saving by households. Although there are indications that the labour market has started to loosen, it is expected to remain tighter than in the February Report in the near term. The unemployment rate is now projected to remain below 4% until the end of 2024, before rising over the second half of the forecast period to around 4 %. CPI inflation was 10.2% in 2023 Q1, higher than expected at the time of the February and March MPC meetings, with the upside surprise concentrated in core goods and food prices. Although still elevated, nominal private sector wage growth and services CPI inflation have been close to expectations. Page 4Bank of England CPI inflation is expected to fall sharply from April, in part as large rises in the price level one year ago drop out of the annual comparison. In addition, the extension in the Spring Budget of the Energy Price Guarantee and declines in wholesale energy prices will both lower the contribution from household energy bills to CPI inflation. However, food price inflation is likely to fall back more slowly than previously expected. Alongside news in other goods prices, this explains why the Committee s modal expectation for CPI inflation now falls back more slowly than in the February Report. In the MPC s latest modal projection conditioned on market interest rates, CPI inflation declines to a little above 1% at the two and three-year horizons, materially below the 2% target. This reflects the emergence of an increasing degree of economic slack and declining external pressures that are expected to reduce CPI inflation. However, there remain considerable uncertainties around the pace at which CPI inflation will return sustainably to the 2% target. The Committee continues to judge that the risks around the inflation forecast are skewed significantly to the upside, reflecting the possibility that the second-round effects of external cost shocks on inflation in wages and domestic prices may take longer to unwind than they did to emerge. The mean CPI inflation profile, which incorporates this risk, is at or just below the 2% target in the medium term. 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. The economy has been subject to a sequence of very large and overlapping shocks. Monetary policy will ensure that, as the adjustment to these shocks continues, CPI inflation will return to the 2% target sustainably in the medium term. Monetary policy is also acting to ensure that longer-term inflation expectations are anchored at the 2% target. The Committee has voted to increase Bank Rate by 0.25 percentage points, to 4.5%, at this meeting. In doing so the MPC is continuing to address the risk of more persistent strength in domestic price and wage setting, as represented by the upward skew in the projected distribution for CPI inflation. The pace at which domestic inflationary pressures ease will depend on the evolution of the economy, including the impact of the significant increases in Bank Rate so far. Uncertainties around the global financial and economic outlook remain elevated. The MPC will continue to monitor closely indications of persistent inflationary pressures, 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 Page 5Bank of England further tightening in monetary policy would be required. The MPC will adjust Bank Rate as necessary to return inflation to the 2% target sustainably in the medium term, in line with its remit. Page 6Bank of England 1: The economic outlook CPI inflation remains well above the 2% target and, at 10.2% in 2023 Q1, was higher than projected in the February Report. Inflation is expected to fall sharply from April, as large rises in the price level one year ago drop out of the annual comparison. This also reflects the extension in the Budget of the Energy Price Guarantee and further falls in wholesale energy prices. Food and other goods price inflation have recently surprised on the upside. They are still expected to decline, but food price inflation in particular is projected to do so at a slower pace than in the February Report. Services CPI inflation has been in line with expectations in February and is projected to remain elevated in the near term. There remain considerable uncertainties around the pace at which CPI inflation will return sustainably to the 2% target. In the modal forecast conditioned on market interest rates, and taking account of stronger paths for food prices and demand growth, CPI inflation is expected to decline somewhat less rapidly compared with the February Report. An increasing degree of economic s