Bank of England — Monetary Policy Report (UK, 2021)

Monetary Policy Committee Monetary Policy Report August 2021 Monetary Policy Report August 2021 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. The Monetary Policy Committee Andrew Bailey, Chair Ben Broadbent Jon Cunliffe Jonathan Haskel Dave Ramsden Michael Saunders Silvana Tenreyro Gertjan Vlieghe 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/2021/august-2021   Bank of England 2021 ISSN 2633-7819 Contents Monetary Policy Summary 1: The economic outlook Recent developments The MPC s projections 1.1: 1.2: 1.3: Key judgements and risks 1.4: Constant rates Box A: The MPC s strategy for the mix of monetary policy instruments to deliver tighter policy Box B: Monetary policy since the May Report 2: Current economic conditions 2.1: Global developments and financial conditions 2.2: Demand and output 2.3: Supply and the labour market Box C: How strong is pay growth? Box D: Agents  update on business conditions 3: In focus   The outlook for inflation 3.1: Global price rises and their impact on UK inflation 3.2: Spare capacity and domestic price pressures 3.3: Inflation expectations 3.4: The MPC s inflation projection Annex: Other forecasters  expectations Glossary and other information i 1 1 3 7 10 12 15 16 17 22 26 31 33 35 36 38 40 42 43 44 Monetary Policy Report August 2021 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 4 August 2021, the Committee judged that the existing stance of monetary policy remained appropriate. The MPC voted unanimously to maintain Bank Rate at 0.1%. The Committee voted unanimously for the Bank of England to maintain the stock of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, at  20 billion. The Committee voted by a majority of 7 1 for the Bank of England to continue with its existing programme of UK government bond purchases, financed by the issuance of central bank reserves, maintaining the target for the stock of these government bond purchases at  875 billion and so the total target stock of asset purchases at  895 billion. The Committee s updated projections for activity and inflation are set out in the accompanying August Monetary Policy Report. They assume that, despite the spread of the Delta variant, the impact of Covid on the UK economy fades further over time. They are also conditioned on the market path for interest rates. Global GDP growth is estimated to have risen sharply in 2021 Q2, as Covid vaccination programmes gathered pace and restrictions were eased further. Partly reflecting the spread of the Delta variant, global growth in Q3 is expected to expand at a slower pace than anticipated in the May Report. Global price pressures have continued to build, reflecting the speed and unevenness of the recovery in activity, and disruptions to supply chains. UK GDP is expected to have risen by 5% in 2021 Q2, leaving it around 4% below its pre-pandemic level and slightly stronger than expected in the May Report. After the MPC s previous meeting, the number of Covid cases continued to rise but has subsequently shown signs of falling back, although there has been a sharp increase in the number of people being asked to self-isolate temporarily. The majority of remaining domestic Covid restrictions have now been lifted. Faster indicators of household spending have been broadly flat, at close to pre-Covid levels, but the housing market has remained strong. GDP is expected to grow by around 3% in Q3, somewhat weaker than expected in the May Report, with a small negative impact from recent developments in the pandemic. UK GDP is projected to recover further over the remainder of the year, reaching its pre-pandemic level in 2021 Q4, with demand growth boosted by a waning impact from Covid. Further out, the pace of GDP growth is expected to slow towards more normal rates, partly reflecting the gradual tightening in the stance of announced fiscal policy. The Labour Force Survey unemployment rate was 4.8% in the three months to May, 1 percentage point higher than at the end of 2019. The inactivity rate was also 1 percentage point above its level at the end of 2019. The number of full and part-time furloughed jobs has continued to decline as demand has recovered, but remained at around 2 million at the end of June. The stock of vacancies has increased further, as have indicators of recruitment difficulties. There appear to have been difficulties in matching available jobs and workers. These frictions are for a period reducing effective supply in the economy. Overall, the MPC judges that spare capacity has been eroded over the past couple of quarters, as demand has outstripped growth in effective supply. Frictions in the labour market are judged likely to dissipate over the forecast period, boosting growth in effective supply capacity. There is uncertainty around these judgements, including how the economy will adjust to the end of the furlough scheme. Private sector regular pay in the three months to May was over 7% higher than a year earlier, and annual growth is projected to have peaked at around 8 % in 2021 Q2. Adjusted for the impact of the furlough scheme, the changing composition of employment during the pandemic and annual base effects, underlying pay growth appears to continue to be around pre-Covid rates. Monetary Policy Report August 2021 Monetary Policy Summary ii Twelve-month CPI inflation rose to 2.5% in June, above the MPC s 2% target and 0.8 percentage points higher than expected in the May Report. Core CPI inflation has also risen further, to 2.3%, as building global input cost pressures have been passed through to some consumer goods prices and, to a lesser degree, the reopening of the economy has led to a pickup in some consumer services and goods prices. CPI inflation is projected to rise temporarily in the near term, to 4% in 2021 Q4, owing largely to developments in energy and other goods prices, before falling back to close to the 2% target. The Committee s central expectation is that current elevated global and domestic cost pressures will prove transitory. Nonetheless, the economy is projected to experience a more pronounced period of above-target inflation in the near term than expected in the May Report. And, alongside temporary constraints on supply, the rapid recovery in demand has eroded spare capacity such that the economy is projected to have a margin of excess demand for a period. In the medium term, conditioned on the market path for interest rates, inflation is projected to fall back to close to the 2% target, and demand and supply are expected to return broadly to balance. The MPC has had policy guidance in place specifying that it does not intend to tighten monetary policy at least until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably. Some members of the Committee judge that, although considerable progress has been made in achieving the conditions of that guidance, the conditions are not yet met fully. The other members judge that the conditions of the guidance have been met fully, but note that the guidance made clear that these have only ever been necessary not sufficient conditions for any future tightening in monetary policy. All members confirm that in judging the appropriate stance of monetary policy, the Committee will, as always, focus on the medium-term prospects for inflation, including medium-term inflation expectations, rather than factors that are likely to be transient. In particular, the Committee will not put undue weight on capacity pressures that are frictional in nature and likely to be temporary. The Committee will be monitoring closely the incoming evidence regarding developments in the labour mar