Bank of England — Monetary Policy Report (UK, 2025)

Bank of England Monetary Policy Report Monetary Policy Committee February 2025 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   Clare Lombardelli   Catherine L Mann   Huw Pill   Dave Ramsden   Alan Taylor 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/2025/february-2025.   Bank of England 2025 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: The long-run equilibrium interest rate Box B: Monetary policy since the November 2024 Report 2: Current economic conditions 2.1: Global economy and financial markets 2.2: Domestic credit conditions 2.3: Domestic activity 2.4: The labour market and slack 2.5: Inflation and wages 2.6: Inflation expectations Box C: The potential effects of trade tariffs on the UK Box D: Monitoring the impacts of changes to National Insurance contributions Box E: The supply side of the economy Box F: Agents  update on business conditions Annex: Other forecasters  expectations Glossary and other information 4 6 8 9 22 28 30 32 42 46 50 55 65 70 75 81 89 96 98 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 5 February 2025, the MPC voted by a majority of 7 2 to reduce Bank Rate by 0.25 percentage points, to 4.5%. Two members preferred to reduce Bank Rate by 0.5 percentage points, to 4.25%. There has been substantial progress on disinflation over the past two years, as previous external shocks have receded, and as the restrictive stance of monetary policy has curbed second-round effects and stabilised longer-term inflation expectations. That progress has allowed the MPC to withdraw gradually some degree of policy restraint, while maintaining Bank Rate in restrictive territory so as to continue to squeeze out persistent inflationary pressures. CPI inflation was 2.5% in 2024 Q4. Domestic inflationary pressures are moderating, but they remain somewhat elevated, and some indicators have eased more slowly than expected. Higher global energy costs and regulated price changes are expected to push up headline CPI inflation to 3.7% in 2025 Q3, even as underlying domestic inflationary pressures are expected to wane further. While CPI inflation is expected to fall back to around the 2% target thereafter, the Committee will pay close attention to any consequent signs of more lasting inflationary pressures. GDP growth has been weaker than expected at the time of the November Monetary Policy Report, and indicators of business and consumer confidence have declined. GDP growth is expected to pick up from the middle of this year. The labour market has continued to ease and is judged to be broadly in balance. Productivity growth has been weaker than previously estimated, and the Committee judges that growth in the supply capacity of the economy has weakened. As a result, the recent slowdown in demand is judged to have led to only a small margin of slack opening up. In support of returning inflation sustainably to the 2% target, the Committee judges that there has been sufficient progress on disinflation in domestic prices and wages to reduce Bank Rate to 4.5% at this meeting. Based on the Committee s evolving view of the medium-term outlook for inflation, a gradual and careful approach to the further withdrawal of monetary policy restraint is appropriate. Bank of England Page 4 In addition to the risks around inflation persistence, there are also uncertainties around the trajectories of both demand and supply in the economy that could have implications for monetary policy. Should there be greater or longer-lasting weakness in demand relative to supply, this could push down on inflationary pressures, warranting a less restrictive path of Bank Rate. If there were to be more constrained supply relative to demand, this could sustain domestic price and wage pressures, consistent with a relatively tighter monetary policy path. The Committee will continue to monitor closely the risks of inflation persistence and what the evolving evidence may reveal about the balance between aggregate supply and demand in the economy. 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 will decide the appropriate degree of monetary policy restrictiveness at each meeting. Bank of England Page 5 1: The economic outlook Progress on disinflation in domestic price and wage pressures has generally continued. In support of returning CPI inflation sustainably to the 2% target, the Committee is maintaining its focus on the persistence of inflationary pressures in the medium term. It also notes the significant uncertainties around the current and prospective balance of demand and supply in the economy. CPI inflation was 2.5% in 2024 Q4, close to expectations at the time of the November Report. CPI inflation excluding energy has continued to decline over the past year reaching around 3 % in the second half of 2024 compared with its peak of nearly 8 % in mid-2023 (Chart 1.1). In large part reflecting recent developments in global energy costs and regulated prices, headline CPI inflation is expected to rise quite sharply in the near term, to 3.7% in 2025 Q3. But the MPC judges that this pickup in headline inflation will not lead to additional second-round effects on underlying domestic inflationary pressures in the forecast (Key judgement 1). The recent slowdown in demand is judged to have led to only a small margin of slack opening up, as growth in the supply capacity of the economy appears to have been weakening over the past year. Within potential supply, labour supply growth has been strong and potential productivity appears to have been very weak. The MPC considers that the labour market is broadly in balance. In the February forecast, the margin of excess supply is expected to widen over the next couple of years, to around  % of potential GDP, before narrowing slightly by the end of the forecast period (Key judgement 2). The unemployment rate is projected to rise gradually to around 4 %. Annual potential supply growth is projected to rise to around 1 % in the medium term, which supports GDP growth picking up from the middle of this year, to over 1 % by the end of the forecast period. There are considerable risks around the path of excess supply in the economy. The Committee has considered carefully the impact of alternative assumptions for the degree to which recent developments in activity may reflect greater weakness in demand relative to supply. It has also considered the more material risk that weakness in the labour market and other uncertainties in the global and UK economies could push down on demand in a longer-lasting way over the forecast period. In the other direction, if there were to be more constrained supply relative to demand, this could sustain domestic price and wage pressures. Bank of England Page 6 Overall, the Committee judges that, while there have been important developments since November, the forecast remains consistent with the second case that it has identified previously regarding the evolution of the remaining persistent inflationary pressures. That is, conditioned on the market path of interest rates, the emerging margin of slack in the economy acts against some continuing second-round effects in domestic prices and wages in order for CPI inflation to fall back to