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

Bank of England Monetary Policy Report Monetary Policy Committee February 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 www.bankofengland.co.uk/monetary-policy- report/2023/february-2023.   Bank of England 2023 ISSN 2633-7819 On 15 March, the Indeed Wage Tracker line in Chart 2.23 was corrected. 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 November 2022 Report 2: Current economic conditions 2.1: Global developments 2.2: Domestic credit conditions 2.3: Domestic activity 2.4: Inflation and wages Box B: Fiscal policy since the November 2022 Report Box C: Agents  update on business conditions 4 6 7 9 30 31 33 41 44 54 63 66 3: In focus   How have the recent shocks to the economy affected potential 72 supply? 73 3.1: What is potential supply? 3.2: How has potential supply evolved over the past? 74 3.3: What are the effects of the recent supply shocks and how persistent will they be? 77 90 3.4: What does this mean for potential supply now and over the MPC s forecast? Annex: Other forecasters  expectations Glossary and other information 92 94 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 1 February 2023, the MPC voted by a majority of 7 2 to increase Bank Rate by 0.5 percentage points, to 4%. Two members preferred to maintain Bank Rate at 3.5%. Global consumer price inflation remains high, although it is likely to have peaked across many advanced economies, including in the United Kingdom. Wholesale gas prices have fallen recently and global supply chain disruption appears to have eased amid a slowing in global demand. Many central banks have continued to tighten monetary policy, although market pricing indicates reductions in policy rates further ahead. UK domestic inflationary pressures have been firmer than expected. Both private sector regular pay growth and services CPI inflation have been notably higher than forecast in the November Monetary Policy Report. The labour market remains tight by historical standards, although it has started to loosen and some survey indicators of wage growth have eased, alongside a gradual decline in underlying output. Given the lags in monetary policy transmission, the increases in Bank Rate since December 2021 are expected to have an increasing impact on the economy in the coming quarters. Near-term data developments will be crucial in assessing how quickly and to what extent external and domestic inflationary pressures will abate. As set out in the accompanying February Monetary Policy Report, the MPC s updated projections show CPI inflation falling back sharply from its current very elevated level, of 10.5% in December, in large part owing to past increases in energy and other goods prices falling out of the calculation of the annual rate. Annual CPI inflation is expected to fall to around 4% towards the end of this year, alongside a much shallower projected decline in output than in the November Report forecast. In the latest modal forecast, conditioned on a market-implied path for Bank Rate that rises to around 4 % in mid-2023 and falls back to just over 3 % in three years  time, an increasing degree of economic slack, alongside falling external pressures, leads CPI inflation to decline to below the 2% target in the medium term. There are considerable uncertainties around this medium-term outlook, and the Committee continues to judge that the risks to inflation are skewed significantly to the upside. Page 4Bank of England 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 0.5 percentage points, to 4%, at this meeting. Headline CPI inflation has begun to edge back and is likely to fall sharply over the rest of the year as a result of past movements in energy and other goods prices. However, the labour market remains tight and domestic price and wage pressures have been stronger than expected, suggesting risks of greater persistence in underlying inflation. The extent to 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. There are considerable uncertainties around the outlook. 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 inflation. If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required. Looking further ahead, 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 5Bank of England 1: The economic outlook Since the MPC s previous forecast in November, wholesale energy prices have fallen significantly, but domestic inflationary pressures have been firmer than expected. Services CPI inflation rose to a 30-year high of 6.8% in December, while nominal annual private sector regular pay growth increased to 7.2% in the three months to November, 0.7 percentage points higher than expected in the November Report. Output is now expected to decline by less than previously expected over the coming year. Even as a margin of slack is projected to open up in the economy, the Committee judges there to be considerable uncertainties around the extent and timing of the expected reduction in domestic, and potentially more persistent, inflationary pressures. In the MPC s central projections, CPI inflation declines below target in the medium term, but there continue to be significant upside risks around these projections. Whether or not those risks crystallise will be a key determinant of the economic outlook over the rest of this year. Following the conclusion of its recent stocktake (Section 3), the Committee judges that the level of estimated potential supply has been reduced, such that the growth of potential supply is likely to be weak by historical standards over the forecast period, averaging almost 1% per year. In the Committee s central projection, GDP is projected to fall slightly throughout 2023 and 2024 Q1, as still-high energy prices and the path of market interest rates weigh on spending. This forecast is consistent with the technical definition of a recession, which is at least two consecutive quarters of falling output. But this is a much shallower profile for the decline in output than in the November Report, in part reflecting a reassessment of the outlook for consumption in light of the recent strength in the labour market, as well as the decline in wholesale energy prices. Four-quarter GDP growth picks up to almost 1% by the end of the projection, although growth is expected to remain well below pre-pandemic rates. Although it has started to loosen, the labour market has remained tight and the UK economy is judged to ha