Bank of England — Monetary Policy Report (UK, 2022)

Bank of England Monetary Policy Report Monetary Policy Committee May 2022 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   Jonathan Haskel   Catherine L Mann   Huw Pill   Dave Ramsden   Michael Saunders   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/2022/may-2022.   Bank of England 2022 ISSN 2633-7819 Bank of England Page 2 Contents Monetary Policy Summary 1: The economic outlook 1.1: The MPC s projections 1.3: Key judgements and risks Box A: Monetary policy since the February 2022 Report 2: Current economic conditions 2.1: Global developments and financial conditions 2.2: Domestic activity and the labour market 2.3: Wages and inflation Box B: How will the Russian invasion of Ukraine affect the UK economy? Box C: Agents  update on business conditions 3: In focus   The economic impacts of the recent rises in energy prices 3.1: How have energy prices changed, and why? 3.2: How do energy prices affect firms? 3.3: How do energy prices affect households? 3.4: How have higher energy prices affected the MPC s projections? Annex 1: Other forecasters  expectations Annex 2: How has the economy evolved recently relative to the MPC s projections? Glossary and other information 4 8 10 23 32 34 36 46 58 70 77 82 82 87 91 97 101 103 109 Bank of England Page 3 Monetary Policy Summary The 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 4 May 2022, the MPC voted by a majority of 6-3 to increase Bank Rate by 0.25 percentage points, to 1%. Those members in the minority preferred to increase Bank Rate by 0.5 percentage points, to 1.25%. Global inflationary pressures have intensified sharply following Russia s invasion of Ukraine. This has led to a material deterioration in the outlook for world and UK growth. These developments have exacerbated greatly the combination of adverse supply shocks that the United Kingdom and other countries continue to face. Concerns about further supply chain disruption have also risen, both due to Russia s invasion of Ukraine and to Covid-19 developments in China. UK GDP is estimated to have risen by 0.9% in 2022 Q1, stronger than expected in the February Monetary Policy Report. The unemployment rate fell to 3.8% in the three months to February, and is likely to fall slightly further in coming months, consistent with a continuing tightening in the labour market and with a margin of excess demand at present. Surveys of business activity have generally remained strong. There have, however, been signs from indicators of retail spending and consumer confidence that the squeeze on real disposable incomes is starting to weigh on the household sector. The level of GDP is expected to be broadly unchanged in Q2. Twelve-month CPI inflation rose to 7.0% in March, around 1 percentage point higher than expected in the February Report. The strength of inflation relative to the 2% target mainly reflects previous large increases in global energy and tradable goods prices, the latter of which is due to the shift in global demand towards durable goods and to supply chain disruptions. The Committee s updated central projections for activity and inflation are set out in the accompanying May Monetary Policy Report. The projections are conditioned on a market- implied path for Bank Rate that rises to around 2 % by mid-2023, before falling to 2% at the end of the forecast period. Fiscal policy is assumed to evolve in line with announced Government policies. Wholesale energy prices are assumed to follow their respective futures curves for the first six months of the projections and remain constant beyond that, in contrast to futures curves, which are downward sloping over coming years. There are material risks around this assumption. Bank of England Page 4 In the May Report central projection, CPI inflation is expected to rise further over the remainder of the year, to just over 9% in 2022 Q2 and averaging slightly over 10% at its peak in 2022 Q4. The majority of that further increase reflects higher household energy prices following the large rise in the Ofgem price cap in April and projected additional large increase in October. The price cap mechanism means that it takes some time for increases in wholesale gas and electricity prices, and their respective futures curves, to be reflected in retail energy prices. Given the operation of the price cap, consumer price inflation is likely to peak later in the United Kingdom than in many other economies, and may therefore fall back later. The expected rise in CPI inflation also reflects higher food, core goods and services prices. Underlying nominal earnings growth has risen by more than projected in the February Report and is expected to strengthen in coming months, given the further tightening of the labour market and some upward pressure from higher price inflation. Companies generally expect to increase their selling prices strongly in the near term, following the sharp rises in their costs, with many reporting confidence that they will be able to rebuild at least some of their margins. Nonetheless, in the May Report central projection, UK GDP growth is expected to slow sharply over the first half of the forecast period. That predominantly reflects the significant adverse impact of the sharp rises in global energy and tradable goods prices on most UK households  real incomes and many UK companies  profit margins. Although the unemployment rate is likely to fall slightly further in the near term, it is expected to rise to 5 % in three years  time given the sharp slowdown in demand growth. Excess supply builds to 2 % by the end of the forecast period. With monetary policy acting to ensure that longer-term inflation expectations are anchored at the 2% target, upward pressure on CPI inflation is expected to dissipate over time. Global commodity prices are assumed to rise no further in the central projection, global bottlenecks ease over time, and the weakening in demand growth and building excess supply lead domestic inflationary pressures to subside. Conditioned on the rising market-implied path for Bank Rate and the MPC s current forecasting convention for future energy prices, CPI inflation is projected to fall to a little above the 2% target in two years  time, largely reflecting the waning influence of external factors, and to 1.3% in three years, well below the target and mainly reflecting weaker domestic pressures. The risks to the inflation projection are judged to be skewed to the upside at these points, given the risks of more persistent strength in nominal wage growth and domestic price setting than assumed. Bank of England Page 5 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 also recognises that there will be occasions when inflation will depart from the target as a result of shocks and disturbances. The economy has recently been subject to a succession of very large shocks. Russia s invasion of Ukraine is another such shock. In particular, should recent movements prove persistent as the central projections assume, the very elevated levels of global energy and tradable goods prices, of which the United Kingdom is a net importer, will necessarily weigh further on most UK households  real incomes and many UK companies  profit margins. This is something monetary policy is unable to prevent. The role of monetary policy is to ensure that, as this real economic adjustment occurs, it does so in a manner consistent with achieving the 2% inflation target sustainably in the medium term, while minimising undesirable volatility in output. Recent developments have exacerbated materially both the near-term peak in CPI inflation, and the prospective negat