BOE keeps rate in unanimous vote as inflation view cut

    The Bank of England (BOE) left its benchmark Bank Rate steady at 0.5 percent, as widely expected, but lowered its forecast for inflation, economic growth and the bank rate due to the fall in crude oil prices and slower growth in emerging market economies.
    The decision by the BOE's 9-member monetary policy committee was unanimous as member Ian McCafferty for the first time since August reversed his view and voted with his colleagues. In the previous five meetings, McCafferty had voted to raise the rate by 25 basis points, arguing that inflation will exceed the BOE's 2.0 percent target.
    But the prospects for accelerating inflation have dimmed as wage growth has been weaker than expected and labor costs are likely to rise slower than previously expected as low inflation moderates future upward pressure on wages.
    "As one of the most open economies in the world, the UK cannot help but be affected by an unforgiving global environment and sustained financial market turbulence, BOE Governor Mark Carney said in his prepared statement.
    In its latest inflation report, the BOE cut its forecast for consumer price inflation to average 0.4 percent in the first quarter of this year, down from November's forecast of 0.7 percent, and to 1.2 percent for the first quarter of 2017 from 1.5 percent.
    By the first quarter of 2018 the BOE expects inflation to average 2.1 percent, above its target, as the past falls in energy prices drops out of comparison and the recent fall in the exchange rate of the pound and lower market rates supports higher wages.
    In December UK inflation rose slightly to 0.2 percent from 0.1 percent in November as deflation of 0.1 percent in September and October was reversed.
    As a consequence of lower inflation, the BOE now expects its bank rate to rise slower than expected. By the first quarter of 2017 the bank rate is expected to remain at the current 0.5 percent, down from the November's forecast of 0.7 percent, before rising to 0.8 percent in Q1 2018, down from 1.1 percent previously seen, and then reach 1.1 percent in first quarter of 2019.
    Although Carney said domestic demand in the UK remained resilient, with robust consumer confidence, rising income and firm investment intentions, a sharp retrenchment in capital spending in the oil and gas sector is underway and deteriorating prospects for emerging market economies pose downside risks to the UK and exports are seen dragging down UK growth.
    Economic growth in the United Kingdom is now expected to average 2.5 percent in 2015, down from the previous projection of 2.7 percent, then ease to 2.2 percent this year, down from 2.5 percent previously seen, before rising to 2.4 percent in 2017 and 2.5 percent in 2018.
    Gross Domestic Product in the UK rose by an annual rate of 1.9 percent in the fourth quarter of 2015, the lowest annual rate in almost 3 years.
    The recent fall in financial markets reflects the prospects of slower global growth, especially in emerging market economies such as China, along with the news about the supply of oil and the risks to the BOE's growth forecasts remain to the downside.
    However, low commodity prices and fiscal and monetary policy should continue to boost income in the UK and its main trading partners and the BOE still expects rising domestic demand to eliminate the limited margin of spare production capacity during this year.


    The Bank of England issued the following statement, along with Governor Mark Carney's opening remarks at a press conference:

"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 3 February 2016, the MPC voted unanimously to maintain Bank Rate at 0.5%.  The Committee also voted unanimously to maintain the stock of purchased assets financed by the issuance of central bank reserves at £375 billion.

In December, twelve-month CPI inflation stood at 0.2%, almost 2 percentage points below the inflation target.  Oil prices were more than a third lower, in sterling terms, than a year earlier.  Together with muted growth in world prices, the appreciation of sterling since early 2013 has pulled down on import prices more broadly.  Overall, these factors can explain the vast majority of the deviation of inflation from the target in December, and to an even greater extent than at the time of the November Inflation Report.  The remainder of the undershoot reflects subdued domestic cost growth, particularly unit labour costs. 

Returning inflation to the 2% target requires balancing the protracted drags from sterling’s past appreciation and low growth in world export prices against increases in domestic cost growth.  Fully offsetting the drag on inflation from external factors over the short run would, in the MPC’s judgement, involve too rapid an acceleration in domestic costs, one that would risk being unsustainable and would lead to undesirable volatility in output and employment.  Given these considerations, the MPC intends to set monetary policy to ensure that growth is sufficient to absorb remaining spare capacity in a manner that returns inflation to the target in around two years and keeps it there in the absence of further shocks.

Global growth has fallen back further over the past three months, as emerging economies have generally continued to slow and as the US economy has grown by less than expected.  There have also been considerable falls in the prices of risky assets and another significant fall in oil prices.  The latter appears largely to reflect news about the supply of oil.  Developments in financial markets seem in part to reflect greater weight being placed on the risks to the global outlook stemming from China and other emerging economies.  Looking ahead, growth in the United Kingdom’s main trading partners should continue to be supported by the boost to real incomes from low commodity prices, and to some degree by monetary and fiscal policy.  But emerging market economies are likely to grow more slowly than in recent years and the risks to the MPC’s central projections of only modest global growth lie to the downside.

Although activity growth in the United Kingdom has slowed to slightly below average rates, the domestic private sector remains resilient.  Consumer confidence is robust, supported by a pickup in real income growth, and overall investment intentions continue to be firm, although a sharp retrenchment in capital spending in the oil and gas sector is under way.  GDP is expected to grow at around average rates over the forecast period as a tighter labour market and rising productivity support real incomes and consumption.  

The MPC has revised down its estimate of the level of potential supply broadly in line with the lower level of demand.  Resilient private domestic demand growth is expected to produce sufficient momentum to eliminate the limited margin of spare capacity during the course of this year.  However, wage growth has been weaker than anticipated and labour costs are expected to rise a little less quickly than thought at the time of the November Inflation Report, contributing to a slower recovery in inflation.  In part that reflects the MPC’s expectation that low realised inflation will continue to moderate the increase in wage pressure in the near term.  The mechanical return to higher rates of inflation as past falls in energy prices drop from the annual comparison, supported by the recent fall in the sterling exchange rate and some additional stimulus from lower market interest rates, should in time reverse this effect and support wage gains.  The MPC judges that inflation expectations remain well anchored, though it remains watchful for signs that low inflation is having more persistent second-round effects on wages.  

The scale of recent commodity price falls means that CPI inflation is likely to remain below 1% until the end of the year.  As the drags from energy and other imported goods unwind, however, domestic cost pressures are projected to build up sufficiently such that, conditioned on the path for Bank Rate implied by market interest rates, CPI inflation is likely to exceed the 2% target slightly at the two-year point and then rise further above it.  This central projection for inflation is modestly below that of three months ago for much of the forecast period but broadly similar by the end.  The MPC judges the risks to the central projection to be skewed a little to the downside in the near term, reflecting the possibility of greater persistence of low inflation. 

There are significant judgements underlying these projections and a range of views among MPC members about the balance of risks to inflation relative to the best collective judgement presented in the February Inflation Report.  At its meeting ending on 3 February, the MPC judged it appropriate to leave the stance of monetary policy unchanged.  The MPC judges it more likely than not that Bank Rate will need to increase over the forecast period to ensure inflation remains likely to return to the target in a sustainable fashion.

All members agree that, given the likely persistence of the headwinds weighing on the economy, when Bank Rate does begin to rise, it is expected to do so more gradually and to a lower level than in recent cycles.  This guidance is an expectation, not a promise.  The actual path Bank Rate will follow over the next few years will depend on the economic circumstances."
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    INFLATION REPORT PRESS CONFERENCE
 Thursday 4th February 2016

Opening remarks by the Governor 

    "Good afternoon.

At its meeting yesterday, the Monetary Policy Committee (MPC) voted 9-0 to maintain Bank Rate at 0.5% and the stock of purchased assets at £375 billion.

When Bank Rate first reached this level almost seven years ago, the global economy had stalled, financial markets had plummeted, the UK banking system was in crisis, and its private domestic demand was collapsing.
Yesterday’s decision was taken amid sluggish global growth, turbulent financial markets, but the ongoing resilience of the UK financial system and its private domestic demand.
Those distinctions explain the difference between the outlook then for a recession and now for a continued, solid expansion.

Global outlook
Global growth has slowed again over the past few months, as emerging economies decelerated further and the US economy grew less than expected. It is now expected to remain around 1 percentage point below past averages this year, despite the boost  to real incomes in advanced economies from lower oil prices and the slight easing of fiscal policy in the US and euro area.

Further ahead, growth in the UK’s main trading partners is expected to remain well below past averages, reflecting the balance of steady growth in advanced economies and an eventual slow, modest recovery in emerging markets.
For some time, the MPC has identified downside risks to global growth from deteriorating prospects in emerging market economies. These include:

• -  the ongoing challenges of economic rebalancing in China;
  
• -  the impact of sharply lower export prices for commodity producers; and
  
• -  a reversal of capital flows and a marked tightening of financial conditions.
  As these risks have begun to materialise, global financial conditions have deteriorated notably, including widespread falls in advanced economy equities, rises in corporate bond spreads, and notable increases in market volatility.
  
  Domestic outlook
  These developments pose downside risks to growth in the UK via trade, financial and confidence channels.
  The outlook for trade is particularly challenging, with net exports expected to drag on UK growth over the forecast period.
  However, there are three domestic offsets to the tightening of global financial conditions.
  
  • -  First, sterling has fallen 31⁄2% since November, the largest decline between Inflation Reports since the crisis.
    
  • -  Second, the gilt yield curve has fallen further, with UK ten-year rates down 25 basis points since November.
    
  • -  And third, the UK financial system is now resilient.
    In this last regard, it is important to recall that major UK banks are well capitalised taking into account the results of the Bank of England’s 2015 stress test, which focussed on a much more severe shock to Chinese and emerging market growth, sharply higher spikes in financial market volatility and steeper falls in risky asset prices. This means that banks are much less likely to amplify such stresses and are likely to be much more able to continue lending to the real economy, even if global conditions were to deteriorate further.
    The resilience of the UK financial sector is matched by the resilience of UK private domestic demand. Despite the slight slowing in the pace of UK growth last year and the prospects for a referendum this year on the UK’s membership of the EU, indicators of household and business confidence currently remain robust.
    After seven lean years, real incomes picked up sharply last year — supported by both record-high employment and lower food and energy prices — and they are expected to grow solidly going forward.
    Business investment growth has been well above its pre-crisis average, with firms investing to meet rising demand while benefiting from favourable credit conditions. With the understandable exception of the oil and gas sector, such strong growth is expected to continue; given high returns on capital and limited spare capacity. 
    
    
    Overall, given global weakness, somewhat more modest wage growth and accelerating fiscal consolidation, the overall pace of growth in the UK is expected to dip below past averages this year, before returning to around 21⁄2% thereafter, as a tighter labour market and rising productivity support real incomes and consumption, and spur business investment.
    This more modest profile for demand compared with our last Report is matched by a lower, but still solid, path for supply growth.
    Developments on the supply side reflect an economy that’s moving from a period of exceptionally rapid employment growth and unusually slow productivity growth to one where growth in both reverts to more normal and sustainable rates.
    With 1 1⁄2 million jobs created over the past three years, unemployment has fallen 3 percentage points to around 5%. Job vacancies relative to unemployment are now back at pre-crisis levels, and people are moving between jobs more frequently.
    Given the resilience of the labour market, the MPC now expects the average hours that people work to resume their pre-crisis downward trend, reflecting the higher job security and a further normalisation of working patterns.
    As labour supply growth has slowed, productivity growth has picked up, with last year’s hourly productivity growth probably the fastest in four years. The MPC expects potential supply growth to rise steadily over the forecast as this pickup in structural productivity growth largely offsets the reversion of labour supply growth to normal rates.
    

    What does this all mean for inflation?
    
    

    Inflation outlook
    As set out in my open letter to the Chancellor today, by far the most important reason for low inflation remains the sharp falls in commodity prices globally. Since our November Report, oil is down by another third.
    The scale of the most recent commodity price falls means that CPI inflation is likely to remain low for much of this year. However, with momentum from private demand expected to eliminate the economy’s margin of spare capacity this year, domestic cost growth should rise. As the drag from external factors wanes, increasing domestic cost pressures are expected to be more than sufficient to return inflation to the 2% target by the start of 2018.

    In the near term, the MPC judges the risks to inflation to lie to the downside. That reflects the possibility that wage pressure takes a little longer to build following a period of low headline inflation. However, the mechanical return to higher rates of inflation as past falls in energy prices drop from the annual comparison should in time reduce this risk. Moreover, the MPC judges that inflation expectations remain well anchored, though it is watchful for signs that low inflation is having more persistent second-round effects on wages.
    
    
    

    Policy outlook

    Returning inflation to target requires balancing the protracted drags from sterling’s past appreciation and lower commodity prices with expected increases in domestic cost growth.
    Fully offsetting the drag on inflation from external factors over the short run would involve too rapid an acceleration in domestic costs – one that would risk being unsustainable and would generate undesirable volatility in output and employment.
    Given these considerations, the MPC is setting policy to return inflation to the target in around two years and keep it there in the absence of further shocks.
    In the central case we set out today, one that is conditioned on a market path for Bank Rate that was around 20 basis points higher on average than last night’s close, CPI inflation is likely to exceed the 2% target slightly at the two-year point and then rise further above it.
    As a consequence, the MPC judges that it is more likely than not that Bank Rate will need to rise over our forecast period.

    As always, there are both upside and downside risks to inflation. It could be higher if the recent weakness in wage growth reflects temporary factors obscuring the underlying tightness of the labour market. Equally, inflation could be lower if global risks crystallise more abruptly or if weak external price pressures further contribute to weaker wage growth.
    

    In any event, the MPC stands ready to act to ensure inflation remains likely to return to the target in a sustainable fashion. We will do the right thing at the right time on Bank Rate.
    ***
    As one of the most open economies in the world, the UK cannot help but be affected by an unforgiving global environment and sustained financial market turbulence.
    However, our prospects for a continued solid expansion are underpinned by the resilience built over the past seven years:
    

    • -  a labour market with record-high employment;
      
    • -  strong private domestic demand reflecting improved private sector balance sheets,
      rising productivity and robust confidence; and
      
    • -  a financial system capitalised for severe emerging market stress so that it can
      continue to serve the real economy. We look forward to your questions."
      
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