What does the inflation report say about UK growth prospects?

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Today the Bank of England published its quarterly Inflation Report. We take a look at its views about the prospects for UK's growth.

UK, OK: despite weaker global growth prospects, there are a number of reasons to believe the UK will sustain above-trend growth over the next couple of years. In particular:

  1. More confident consumers: as a result of a strong labour market, low interest rates, and the prospect of real pay growth
  2. Business investment growth: is expected to continue at well above its historic rate.
A closer look at business investment:

The prospects for continued growth in business investment are good, encouraged by growth in the domestic economy. The inflation report notes that surveys suggest a continuation of strong business investment in the near term. Indeed our own surveys show that the balance of manufacturers planning to expand investment remains above historic averages.

Recent data revisions in the Blue Book suggest that the UK recovery has been better balanced than previously estimated, with business investment playing a greater role. However, the Bank revised down its forecasts for business investment a little, noting that stronger growth in the past may mean there was less requirement for catch up expenditure.

Risks to the forecast: The key downside risk to growth remains weakness in the Eurozone, as this would continue to limit export demand. However, the Bank also identifies upside risks, namely that there is greater momentum than expected behind growth in the US or that there are larger-than-expected impacts from monetary policy by the ECB or the BoJ.

A closer look at exports:

There has been little improvement in the UK’s balance of trade over the last couple of years and the near-term outlook for external demand – and therefore exports – is weaker than was previously expected.

This is particularly due to weakness in the Eurozone: the latest Eurozone PMI may have strengthened slightly, but it remains only just above the 50-level, suggesting growth will be moderate at best in the fourth quarter of this year. As the Inflation Report points out, there is no reason to think growth will gain pace any time soon, either. The Eurozone faces a range of structural challenges which will weigh on growth for some time.

The near-term outlook for emerging markets is for a gradual increase in demand as weak oil prices support demand. However, there are a number of risks for these markets, in particular, the potential for capital outflows if financial market sentiment weakens. Greater uncertainty about the global growth outlook may mean investors move away from riskier assets.

In contrast US growth is likely to provide some support for demand after a strong third quarter.


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