The BOE, which in August cut the Bank Rate to the current 0.25 percent and launched a range of stimulus measures following the June vote to exit the European Union, now expects economic growth of 2.0 percent this year, sharply up from its November forecast of 1.4 percent.
The UK economy is expected to expand by 1.6 percent in 2018, up from the earlier forecast of 1.5 percent and for 2019 growth is seen at 1.7 percent, up from 1.6 percent.
"Domestic demand has been stronger than expected over the past few months, and there have been relatively few signs of the slowdown in consumer spending that the Committee had anticipated following the referendum," the BOE said.
In the fourth quarter of 2016 the UK economy grew by an annual rate of 2.2 percent, the same as in the third quarter.
In contrast to expectations, UK households have not reined in their spending in anticipation of higher inflation and thus lower real incomes, reducing their savings rate and raising their debt levels.
In addition, the BOE said the raised growth outlook reflected government fiscal stimulus, improved global growth, higher equity prices and supporting credit conditions.
But uncertainty over the UK's future trading position within Europe continues to weigh on business investment, which is seen lower in three years that in pre-Brexit projections.
Continued moderate growth in wages and higher import prices will also weaken the rise in household income in coming years, resulting a slowdown in consumer spending, BOE said.
UK inflation has accelerated in recent months and rose to 1.6 percent in December from 1.2 percent in November, boosted by higher import prices from the fall in the pound, and BOE said "further substantial increases are very likely over the coming months."
In the first quarter of this year inflation is seen averaging 2.0 percent, in line with the BOE's target, and up from 1.8 percent forecast in November. In the first quarter of next year inflation is seen hitting 2.7 percent, down from 2.8 percent previously forecast, but then remain at an unchanged 2.6 percent in the first quarter of 2019 before easing to 2.4 percent by Q1 2020.
Higher inflation is expected by financial markets to lead to an increase in rates by the BOE, with forward rates seen at 0.3 percent in Q1 2018, then 0.5 percent in Q1 2019 and 0.7 percent in Q1 2020.
Despite high inflation, the BOE reiterated that it still considers it appropriate to allow inflation to remain above its target for a "somewhat longer period than usual" as offsetting the impact of a weaker pounds on inflation would only be achievable by raising unemployment and thus income growth.
However, the BOE added that "there are limits to the extent that above-target inflation can be tolerated," with its policy stance depending on the trade-off between inflation and economic slack.
The pound fell sharply following the June vote to leave the EU but began to rise in recent weeks.
But it fell sharply in response to today's BOE statement and was trading at 1.255 to the U.S. dollar, down from1.266 yesterday. Compared with the start of this year, the pound is down 2 percent and down 18 percent since the start of 2016.
The Bank of England released the following 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 1 February 2017, the Committee voted unanimously to maintain Bank Rate at 0.25%. The Committee voted unanimously to continue with the programme of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, totalling up to £10 billion. The Committee also voted unanimously to maintain the stock of UK government bond purchases, financed by the issuance of central bank reserves, at £435 billion.
As the MPC had observed at the time of the UK’s referendum on membership of the EU, the appropriate path for monetary policy depends on the evolution of demand, potential supply, the exchange rate, and therefore inflation. The Committee’s latest economic projections are contained in the February Inflation Report. The MPC has increased its central expectation for growth in 2017 to 2.0% and expects growth of 1.6% in 2018 and 1.7% in 2019. The upgraded outlook over the forecast period reflects the fiscal stimulus announced in the Chancellor’s Autumn Statement, firmer momentum in global activity, higher global equity prices and more supportive credit conditions, particularly for households. Domestic demand has been stronger than expected over the past few months, and there have been relatively few signs of the slowdown in consumer spending that the Committee had anticipated following the referendum. Nevertheless, continued moderation in pay growth and higher import prices following sterling’s depreciation are likely to mean materially weaker household real income growth over the coming few years. As a consequence, real consumer spending is likely to slow.
In preparing the February Report, the MPC undertook its scheduled regular assessment of aggregate supply-side conditions. Pay growth, although edging up, has remained persistently subdued by historical standards – strikingly so in light of the decline in the rate of unemployment to below 5%. This is likely to have reflected somewhat stronger labour supply than previously assumed and, therefore, the presence of a greater margin of slack in the labour market, restraining wage increases. This updated assessment means that the stronger path for demand in the February projection is roughly matched by higher supply capacity. Combined with the 3% appreciation of sterling and a somewhat higher yield curve over the past three months, that results in a projected path of inflation that is similar to the one expected in November, despite the stronger growth outlook.
The value of sterling remains 18% below its peak in November 2015, reflecting investors’ perceptions that a lower real exchange rate will be required following the UK’s withdrawal from the EU. Over the next few years, a consequence of weaker sterling is that the higher imported costs resulting from it will boost consumer prices and cause inflation to overshoot the 2% target. This effect is already becoming evident in the data. CPI inflation rose to 1.6% in December and further substantial increases are very likely over the coming months. In the central projection, conditioned on market yields that are somewhat higher than in November, inflation is expected to increase to 2.8% in the first half of 2018, before falling back gradually to 2.4% in three years’ time. Inflation is judged likely to return to close to the target over the subsequent year. Measures of inflation compensation derived from financial markets have stabilised at around average historical levels, having increased during late 2016 as concerns about a period of unusually low inflation faded.
Monetary policy cannot prevent either the real adjustment that is necessary as the UK moves towards its new international trading arrangements or the weaker real income growth that is likely to accompany it over the next few years. Attempting to offset fully the effect of weaker sterling on inflation would be achievable only at the cost of higher unemployment and, in all likelihood, even weaker income growth. For this reason, the MPC’s remit specifies that in such exceptional circumstances the Committee must balance the trade-off between the speed with which it intends to return inflation to the target and the support that monetary policy provides to jobs and activity. At its February meeting, the MPC continued to judge that it remained appropriate to seek to return inflation to the target over a somewhat longer period than usual, and that the current stance of monetary policy remained appropriate to balance the demands of the Committee’s remit.
As the Committee has previously noted, however, there are limits to the extent that above-target inflation can be tolerated. The continuing suitability of the current policy stance depends on the trade-off between above-target inflation and slack in the economy. The projections described in the Inflation Report depend in good part on three main judgements: that the lower level of sterling continues to boost consumer prices broadly as expected, and without adverse consequences for expectations of inflation further ahead; that regular pay growth does indeed remain modest, consistent with the Committee’s updated assessment of the remaining degree of slack in the labour market; and that the hitherto resilient rates of household spending growth slow as real income gains weaken. In judging the appropriate policy stance, the Committee will be monitoring closely the incoming evidence regarding these and other factors. For instance, if spending growth slows more abruptly than expected, there is scope for monetary policy to be loosened. If, on the other hand, pay growth picks up by more than anticipated, monetary policy may need to be tightened to a greater degree than the gently rising path implied by market yields. Monetary policy can respond, in either direction, to changes to the economic outlook as they unfold to ensure a sustainable return of inflation to the 2% target. "
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