As widely expected, today’s Inflation Report saw monetary policy unchanged, marking exactly 10 years (!) from the last time we saw an interest hike in the UK. Once more the devil is in the detail, namely how the latest run of data has changed the balance of views in the Monetary Policy Committee (MPC) and the Bank of England’s (BoE) economic projections.
No more dissent
The March MPC minutes indicated that it would take little more upside news on the UK economy for other members to join Kirsten Forbes in considering a reduction in monetary policy support. The news was decidedly mixed however, with strong survey data contradicted by a slowdown in official GDP growth. The result was no change in the voting make-up of the MPC or a 7-1 vote in favour of maintaining the current level of interest rates and asset purchases.
Growth forecast for 2017 cut…but only slightly
The MPC cut its GDP growth forecast, but only slightly, from 2.0% to 1.9% for 2017. This reflects a softer profile for consumption this year, as higher inflation and subdued wage growth eat into households’ real incomes.
However, this softer consumption profile is almost entirely offset in the Bank’s projections by rising net trade and investment. The mix of improving global economic activity and lower sterling is prompting UK exporters to increase capacity and push through with the business investment that goes with it.
What’s more the Bank of England is more optimistic about 2018 and 2019, upgrading its growth forecast for both by 0.1pp to 1.7% and 1.8% respectively.
Jobs over inflation
The key trade-off the MPC has been called to manage ever since the sterling depreciation has been between supporting real economic activity and controlling inflation. The Bank once more stuck to its guns, judging that removing policy support to prop up the exchange rate and therefore return inflation to its 2% target would come at the unacceptable cost of unemployment. The Bank is therefore willing to tolerate – although once again reiterated its limits to that tolerance – higher inflation over the forecast period to maintain support for jobs and growth.
The inflation forecast was tweaked to peak at 2.8% in Q4 2017 but start waning from Q1 2018 – both earlier than expected in the February Inflation Report. The overshoot from the 2% inflation target is entirely accounted for by the sterling depreciation and according to the BoE, domestic price pressures will determine where inflation settles once that impact fades.
A trio of key judgments
The Bank is basing its growth and inflation projection on three key judgements:
Crucially, the BoE’s forecasts are also conditioned on the assumption that the adjustment to the United Kingdom’s new relationship with the EU is smooth.
Hawkish tone remains
All in all, the tone of the May Inflation Report was little changed from February, with the impact of changes in economic indicators largely balancing out. Slightly slower growth this year offset by slightly higher growth next year. Lower growth in household consumption offset by better net trade and investment. Higher inflation now offset by lower inflation later.
This leaves us with the slightly more hawkish tone we saw in the March MPC minutes, summed up in the last sentence of the Monetary Policy Summary:
“On the whole, the Committee judges that, if the economy follows a path broadly consistent with the May central projection, then monetary policy could need to be tightened by a somewhat greater extent over the forecast period than the very gently rising path implied by the market yield curve underlying the May projections.”
So if it all goes to plan we might see the first rise in interest rates for a decade sooner rather than later.