Bank of England — Monetary Policy Report (UK, 2020)

Monetary Policy Committee Monetary Policy Report August 2020 On 7 August, the third panel in Chart 2.18 was corrected. Missing data for 2023 were also added to the May market path for policy rates in the euro area in Chart 2.7. Monetary Policy Report August 2020 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 Andrew Haldane 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 http://www.bankofengland.co.uk/report/2020/monetary-policy-report-financial-stability-report-august-2020   Bank of England 2020 ISSN 2633-7819 Contents Monetary Policy Summary 1 The economic outlook Recent developments The MPC s projections Key judgements and risks Constant rate projections 1.1 1.2 1.3 1.4 Box 1 Negative policy rates Box 2 Monetary policy since the May Report 2 Current economic conditions The global economy Financial markets and credit conditions Demand and output Employment, costs and prices Insights from Bank surveys on the impact of Covid-19 on households  finances 2.1 2.2 2.3 2.4 Box 3 Box 4 Agents  update on business conditions 3 In focus The outlook for the labour market 3.1 3.2 3.3 How might the labour market evolve in the second half of 2020? How long will higher unemployment persist beyond 2020? The MPC s projection for unemployment 4 In focus Spare capacity and domestic price pressures The impact of Covid-19 on spare capacity The impact of spare capacity on domestic price pressures The MPC s projections for spare capacity and inflation 4.1 4.2 4.3 Box 5 Measuring consumer price inflation during Covid-19 Annex Other forecasters  expectations Glossary and other information i 1 1 3 8 10 12 16 17 18 21 25 31 35 37 40 41 43 45 46 46 48 51 51 52 53 Monetary Policy Report August 2020 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. In that context, its challenge at present is to respond to the economic and financial impact of the Covid-19 pandemic. At its meeting ending on 4 August 2020, the MPC voted unanimously to maintain Bank Rate at 0.1%. The Committee voted unanimously for the Bank of England to continue with its existing programmes of UK government bond and sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, maintaining the target for the total stock of these purchases at  745 billion. The Committee s projections for activity and inflation are set out in the accompanying August Monetary Policy Report. Although recent developments suggest a less weak starting point for the Committee s latest projections, it is unclear how informative they are about how the economy will perform further out. The outlook for the UK and global economies remains unusually uncertain. It will depend critically on the evolution of the pandemic, measures taken to protect public health, and how governments, households and businesses respond to these factors. The MPC s projections assume that the direct impact of Covid-19 on the economy dissipates gradually over the forecast period. Given the inherent uncertainties regarding the evolution of the pandemic, the MPC s medium-term projections are a less informative guide than usual. Global activity has strengthened over recent months, although it generally remains below its level in 2019 Q4. Covid-19 has continued to spread rapidly within a number of emerging market economies, however, and there has been a renewed rise in cases in many advanced economies. UK GDP is expected to have been over 20% lower in 2020 Q2 than in 2019 Q4. But higher-frequency indicators imply that spending has recovered significantly since the trough in activity in April. Payments data suggest that household consumption in July was less than 10% below its level at the start of the year. Housing market activity appears to have returned to close to normal levels, despite signs of a tightening in credit supply for some households. There is less evidence available on business spending, but surveys suggest that business investment is likely to have fallen markedly in Q2 and investment intentions remain very weak. Employment appears to have fallen since the Covid-19 outbreak, although this has been very significantly mitigated by the extensive take-up of support from temporary government schemes. Surveys indicate that many workers have already returned to work from furlough, but considerable uncertainty remains about the prospects for employment after those support schemes unwind. In the near term, the unemployment rate is projected to rise materially, to around 7 % by the end of the year, consistent with a material degree of spare capacity. In the MPC s central projection, GDP continues to recover beyond the near term, as social distancing eases and consumer spending picks up further. Business investment also recovers, but somewhat more slowly. Unemployment declines gradually from the beginning of 2021 onwards. Activity is supported by the substantial fiscal and monetary policy actions in place. Nonetheless, the recovery in demand takes time as health concerns drag on activity. GDP is not projected to exceed its level in 2019 Q4 until the end of 2021, in part reflecting persistently weaker supply capacity. Given the scale of the movements in output, as well as the inherent uncertainty over the factors determining the outlook, the evolution of the balance between demand and supply is hard to assess. The MPC s central projection implies that a margin of spare capacity is likely to remain until the end of next year. The risks to the outlook for GDP are judged to be skewed to the downside. Monetary Policy Report August 2020 Monetary Policy Summary ii Twelve-month CPI inflation increased to 0.6% in June from 0.5% in May. CPI inflation is expected to fall further below the 2% target and average around  % in the latter part of the year, largely reflecting the direct and indirect effects of Covid-19. These include the impact of energy prices and the temporary cut in VAT for hospitality, holiday accommodation and attractions. As these effects unwind, inflation rises, supported by a gradual strengthening of domestic price pressures as spare capacity diminishes. In the MPC s central projection, conditioned on prevailing market yields, CPI inflation is expected to be around 2% in two years  time. The Committee will continue to monitor the situation closely and stands ready to adjust monetary policy accordingly to meet its remit. The MPC will keep under review the range of actions that could be taken to deliver its objectives. The Committee does not intend to tighten monetary policy until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably. At this meeting, the Committee judges that the existing stance of monetary policy remains appropriate. Monetary Policy Report August 2020 Section 1 The economic outlook 1 1 The economic outlook The spread of Covid-19 and the actions to contain it have had a dramatic impact on the UK and many countries around the world. Global activity fell sharply during the first few months of 2020. Since then, output has recovered, but remains below levels at the start of the year. The outlook for the UK and global economies remains unusually uncertain. It will depend critically on the evolution of the pandemic, measures taken to protect public health, and how governments, households and businesses respond to these factors. The MPC s projections assume that the direct impact of Covid-19 on the economy dissipates gradually over the forecast p