Bank of England — Inflation Report (UK, 2018)

Inflation Report February 2018 Inflation Report February 2018 In order to maintain price stability, the Government has set the Bank s Monetary Policy Committee (MPC) a target for the annual inflation rate of the Consumer Prices Index of 2%. Subject to that, the MPC is also required to support the Government s economic policy, including its objectives for growth and employment. The Inflation Report is produced quarterly by Bank staff under the guidance of the members of the Monetary Policy Committee. It serves two purposes. First, its preparation provides a comprehensive and forward-looking framework for discussion among MPC members as an aid to our decision-making. Second, its publication allows us to share our thinking and explain the reasons for our decisions to those whom they affect. Although not every member will agree with every assumption on which our projections are based, the fan charts represent the MPC s best collective judgement about the most likely paths for inflation, output and unemployment, as well as the uncertainties surrounding those central projections. This Report has been prepared and published by the Bank of England in accordance with section 18 of the Bank of England Act 1998. The Monetary Policy Committee: Mark Carney, Governor Ben Broadbent, Deputy Governor responsible for monetary policy Jon Cunliffe, Deputy Governor responsible for financial stability Dave Ramsden, Deputy Governor responsible for markets and banking Andrew Haldane Ian McCafferty Michael Saunders Silvana Tenreyro Gertjan Vlieghe PowerPoint  versions of the Inflation Report charts and Excel spreadsheets of the data underlying most of them are available at www.bankofengland.co.uk/inflation-report/2018/february-2018   Bank of England 2018 ISSN 2514-4103 (Online) Contents Monetary Policy Summary 1 Global economic and financial market developments 1.1 Global economic developments 1.2 Commodity markets and developments in inflation 1.3 Developments in financial markets Box 1 Monetary policy since the November Report Box 2 Monitoring the effects of the rise in Bank Rate on retail interest rates 2 Demand and output 2.1 Output 2.2 Household spending 2.3 Housing 2.4 Government 2.5 Net trade and the current account 2.6 Business investment Box 3 Brexit and business investment 3 Supply and the limits to growth Slack in the economy 3.1 3.2 The outlook for potential supply Box 4 The equilibrium rate of unemployment Box 5 The implications of changing demographics for UK labour supply 4 Costs and prices 4.1 Consumer price developments and the near-term outlook 4.2 External cost pressures 4.3 Domestic cost pressures 4.4 Inflation expectations 5 Prospects for inflation The MPC s key judgements and risks 5.1 5.2 The projections for demand, unemployment and inflation Box 6 Revisions to the MPC s productivity projections Box 7 Other forecasters  expectations Glossary and other information i 1 1 3 4 5 8 10 10 11 13 14 14 15 17 19 19 21 22 25 28 28 29 30 32 34 36 42 41 44 45 Monetary Policy Summary i 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 7 February 2018, the MPC voted unanimously to maintain Bank Rate at 0.5%. The Committee voted unanimously to maintain the stock of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, at  10 billion. The Committee also voted unanimously to maintain the stock of UK government bond purchases, financed by the issuance of central bank reserves, at  435 billion. The MPC s latest projections for output and inflation are set out in detail in the accompanying February Inflation Report. The global economy is growing at its fastest pace in seven years. The expansion is becoming increasingly broad-based and investment driven. Notwithstanding recent volatility in financial markets, global financial conditions remain supportive. UK net trade is benefiting from robust global demand and the past depreciation of sterling. Along with high rates of profitability, the low cost of capital and limited spare capacity, strong global activity is supporting business investment, although it remains restrained by Brexit-related uncertainties. Household consumption growth is expected to remain relatively subdued, reflecting weak real income growth. GDP growth is expected to average around 1 % over the forecast, a slightly faster pace than was projected in November despite the updated projections being conditioned on the higher market-implied path for interest rates and stronger exchange rate prevailing in financial markets at the time of the forecast. While modest by historical standards, that rate of growth is still expected to exceed the diminished rate of supply growth. Following its annual assessment of the supply side of the economy, the MPC judges that the UK economy has only a very limited degree of slack and that its supply capacity will grow only modestly over the forecast, averaging around 1 % per year. This reflects lower growth in labour supply and rates of productivity growth that are around half of their pre-crisis average. As growth in demand outpaces that of supply, a small margin of excess demand emerges by early 2020 and builds thereafter. CPI inflation fell from 3.1% in November to 3.0% in December. Inflation is expected to remain around 3% in the short term, reflecting recent higher oil prices. More generally, sustained above-target inflation remains almost entirely due to the effects of higher import prices following sterling s past depreciation. These external forces slowly dissipate over the forecast, while domestic inflationary pressures are expected to rise. The firming of shorter-term measures of wage growth in recent quarters, and a range of survey indicators that suggests pay growth will rise further in response to the tightening labour market, give increasing confidence that growth in wages and unit labour costs will pick up to target-consistent rates. On balance, CPI inflation is projected to fall back gradually over the forecast but remain above the 2% target in the second and third years of the MPC s central projection. As in previous Reports, the MPC s projections are conditioned on the average of a range of possible outcomes for the United Kingdom s eventual trading relationship with the European Union. The projections also assume that, in the interim, households and companies base their decisions on the expectation of a smooth adjustment to that new trading relationship. Developments regarding the United Kingdom s withdrawal from the European Union   and in particular the reaction of households, businesses and asset prices to them   remain the most significant influence on, and source of uncertainty about, the economic outlook. In such exceptional circumstances, the MPC s remit specifies that the Committee must balance any trade-off between the speed at which it intends to return inflation sustainably to the target and the support that monetary policy provides to jobs and activity. Over the past year, a steady absorption of slack has reduced the degree to which it was appropriate for the MPC to accommodate an extended period of inflation above the target. Consequently, at its November 2017 meeting, the Committee tightened modestly the stance of monetary policy in order to return inflation sustainably to the target. Since November, the prospect of a greater degree of excess demand over the forecast period and the expectation that inflation would remain above the target have further diminished the trade-off that the MPC is required to balance. It is therefore appropriate to set monetary policy so that inflation returns sustainably to its target at a more conventional horizon. The Committee judges that, were the economy to evolve broadly in line with the February Inflation Report projections, monetary policy would need to be tightened somewhat earlier and by a somewhat greater extent over the forecast period than anticipated at the time of the November Report, in order to return inflation sustainably to the target. In light of these considerations, all members thought that the current policy stance remained appropriate to balance the demands of the MPC s remit. Any future increases in Bank Rate are expected to be at a gradual pace and to a limited extent. The Committee will monitor closely the incoming evidence on the evolving economic outlook, and stands ready to respond to developments as they unfold to ensure a sustainable return of inflation to the 2% target. ii Inflation Report February 2018 Section 1 Global economic and financial market developments 1 1 Global economic and financial market developments The outlook for global growth has strengthened further. As growth has recovered, spare capacity has diminished, and market interest rates imply some gradual withdrawal of global monetary policy stimulus over coming years. Sustaining current rates of global GDP growth has become increasingly dependent on a recovery in productivity growth. Chart 1.1 Survey indicators point to robust advanced economy growth Survey measures of international output growth Differences from averages since 2000 (number of standard deviations) United States(a) Euro area(b) World(c) 2006 08 10 12 14 16 18 3 2 1 + 0   1 2 3 4 5 Sources: IHS Markit, JPMorgan, Thomson Reuters Datastream, US Bureau of Economic Analysis, US Institute for Supply Management (ISM) and Bank calculations. (a) Manufacturing production and non-manufacturing business activity ISM survey indices of monthly output growth, weighted together using their nominal shares in value a