Current economic conditions

2.1 Global developments and financial conditions

Global GDP growth has been weakening…

Global output growth has slowed since mid-2018. Four-quarter PPP-weighted global growth was close to 4% in 2018 Q2, but has fallen to under 3% in 2019 Q2. That slowing has been broadly based across advanced economies and emerging markets (Chart 2.2). Forward-looking indicators remain weak. The manufacturing export orders PMI fell to its lowest level since 2012 in August. It has recovered slightly since, but remains well below the 50 no-change mark (Chart 2.3). That suggests that output growth will remain subdued in the near term.

Chart 2.2 Output growth has slowed across advanced economies and emerging markets

Four-quarter PPP-weighted GDP growth ^(a)

Sources: Eikon from Refinitiv, IMF World Economic Outlook (WEO) and Bank calculations.

(a) Constructed using real GDP growth rates of 189 countries weighted according to their shares in world GDP using the IMF’s purchasing power parity (PPP) weights.

Chart 2.3 Survey indicators of global output growth have fallen, particularly in the manufacturing sector

Global purchasing managers’ indices ^(a)

Sources: Eikon from Refinitiv, IHS Markit and JPMorgan.

(a) Measures of current monthly services output, manufacturing output and manufacturing export orders growth based on the results of surveys in 44 countries. Together these countries account for an estimated 89% of global GDP.

…and there has been some further downside news since August.

PPP-weighted global output is estimated to have grown by 0.7% in 2019 Q3, slightly lower than expected in August. Downside news has been concentrated in the euro area, where quarterly GDP growth was 0.2%. Growth in emerging markets has also been a little weaker than the MPC’s August projection, mainly due to weaker-than-expected growth in India.

The composition of global GDP growth is less balanced than in 2018.

The recent weakening of global output growth largely reflects slower investment growth. In major advanced economies, four-quarter investment growth peaked at 4.4% in late 2017, but has since fallen to 1.5% in 2019 Q2. Global growth has become increasingly reliant on consumer spending, which has remained relatively robust (Chart 2.4).

The slowdown partly reflects increasing trade protectionism.

As discussed in Section 3, trade protectionism has increased since mid-2018. This is estimated to be weighing on global growth, alongside other factors. Trade protectionism has particularly affected the manufacturing sector: the global manufacturing PMI has risen very slightly in recent months, but remains below 50 (Chart 2.3). The services sector has been more resilient so far: the global services PMI has fallen somewhat, but remains above 50.

Monetary policy in major economies has loosened in 2019…

A number of central banks have lowered policy rates during 2019 (Chart 2.5) and market-implied paths for policy rates have fallen in some countries (Chart 2.6). In September the European Central Bank (ECB) Governing Council announced a package of measures which included a cut to the deposit rate to -0.5% and asset purchases of €20 billion a month. The ECB announced that asset purchases would run for as long as necessary to reinforce the accommodative impact of its policy rates. In October the Federal Open Market Committee reduced the target range for the federal funds rate to 1.5%–1.75%, the second cut since the August Report. The market-implied path for US policy rates has also fallen since August and is consistent with two further cuts to the federal funds rate over the next two years. Forward interest rates for the UK and euro area have changed by less than in the US. Generally global bond yields are low: around US$13 trillion of global investment-grade debt is now trading with a negative yield.

Chart 2.4 Investment growth has weakened across advanced economies, but consumption growth has been resilient

Investment and consumption in the G7 economies ^(a)

Sources: Eikon from Refinitiv, IMF WEO, OECD and Bank calculations.

(a) Weighted by PPP.

Chart 2.5 The number of G20 central banks cutting policy rates has increased during 2019

G20 central banks changing policy rates each month

Sources: Bank for International Settlements, Bloomberg Finance L.P. and Bank calculations.

…and fiscal policy has been eased.

Government consumption growth across the G7 economies was 0.8% in 2019 Q2, the highest in a decade. The OECD estimates that the structural government deficit across advanced economies widened to more than 3% of GDP in 2019 (Chart 2.7). Widening structural deficits in the US and some euro-area countries have contributed to that change.

Global financial conditions are a little looser than in August.

The fall in US forward interest rates means that global financial conditions are a little looser than in August. Prices of risky assets — such as equities and corporate bonds — are little changed on average. Accommodative financial conditions is one reason why the MPC expects global growth to stabilise in the near term. PPP-weighted global GDP is expected to grow by 0.7% in 2019 Q4, similar to the previous quarter but slightly below the MPC’s August projection.

Chart 2.6 The market-implied paths for US interest rates has fallen further since the August Report

International forward interest rates ^(a)

Sources: Bloomberg Finance L.P. and Bank calculations.

(a) All data as of 30 October 2019. The November 2019, August 2019 and November 2018 curves are estimated using instantaneous forward overnight index swap rates in the 15 working days to 30 October 2019, 24 July 2019 and 24 October 2018 respectively.
(b) Upper bound of the target range.

Chart 2.7 Fiscal policy has been eased in OECD countries

OECD structural budget balance ^(a)

Source: OECD Economic Outlook.

(a) Cyclically adjusted general government net lending, based on data from 31 countries.

Sterling has strengthened as the perceived chance of a no-deal Brexit has fallen.

Sterling has risen by around 4% since the August Report (Chart 2.8) as the perceived risk of a no-deal Brexit has receded. Sterling implied volatility remains elevated compared with other major currency pairs (Chart 2.9), however, suggesting that the outlook for sterling remains particularly uncertain. With forward interest rates little changed since August (Table 2.A), the sterling appreciation has led to a tightening of UK financial conditions (Chart 2.10).

Chart 2.8 Sterling has risen by around 4% since August

Sterling ERI

Chart 2.9 Sterling implied volatility is elevated relative to both the US dollar and the euro

Three-month implied volatilities ^(a)

Sources: Bloomberg Finance L.P. and Bank calculations.

(a) Measures of volatility based on option contracts.

Table 2.A Interest rates are at similar levels to August

Financial market indicators ^(a)

Sources: Bloomberg Finance L.P., Eikon from Refinitiv, ICE/BoAML Global Research and Bank calculations.

(a) Fifteen working day averages to 24 July 2019 for the August Report and to 30 October 2019 for the November Report.
(b) Instantaneous forward overnight index swap rate.
(c) Per cent. Change expressed in percentage point terms.
(d) Basis points. Based on option-adjusted spreads between government bond yields and non-financial corporate bonds.
(e) Index level. Changes expressed in percentage terms.
(f) Index: 4 January 2016 = 100. Change expressed in percentage terms. UK domestically focused companies are defined as those generating at least 70% of their revenues in the United Kingdom.
(g) Index: January 2005 = 100. Change expressed in percentage terms.

Chart 2.10 The sterling appreciation since August has led to a tightening in UK financial conditions

Contributions to changes in the UK Monetary and Financial Conditions Index since the August 2019 Report ^(a)

Sources: Bloomberg Finance L.P., Eikon from Refinitiv, ICE/BoAML Global Research and Bank calculations.

(a) The UK Monetary and Financial Conditions Index (MFCI) summarises information from the following series: short-term and long-term interest rates, the sterling ERI, corporate bond spreads, equity prices, and household and corporate bank lending spreads. The series weights are based on the marginal impact of each variable on the UK GDP forecast. The chart shows changes in the MFCI from the average level over the 15 working days to 24 July 2019. An increase in the MFCI signals tighter financial conditions and a decrease signals looser conditions. For more information, see the Bank Overground post ‘How can we measure UK financial conditions?’.

There have been some signs of tighter corporate credit conditions.

Corporate credit conditions have been accommodative in recent years, particularly for large firms. But there are some tentative signs that conditions have tightened slightly. An increasing proportion of contacts reported to the Bank’s Agents that finance has become slightly more expensive or less available over the past year, and the range of sectors affected had broadened (Box 3). The availability of bank lending was expected to fall in Q4, according to the Credit Conditions Survey. Actual lending volumes have held up so far, however. Corporate bond issuance and bank lending were relatively strong in September.

2.2 Demand and output

UK GDP growth has been volatile this year.

UK growth has been volatile this year, largely because of Brexit-related factors. GDP increased by 0.6% in Q1, with activity boosted by stockbuilding in the UK and elsewhere in the EU ahead of the original March Brexit deadline (Chart 2.11). GDP then fell by 0.2% in Q2 as firms partially ran down those stocks. The fall also reflected a sharp decline in car production, as some factories were shut down in April as part of Brexit-related contingency plans. This was the first quarterly fall in GDP since 2012.

GDP growth appears to have returned to positive territory in Q3. Based on official data to August, growth is expected to have been 0.4% (Chart 2.11). Bank staff expect growth to have been boosted by a rebound in car production and by a small amount of stockbuilding ahead of the October Brexit deadline.

Abstracting from temporary factors, underlying growth has slowed.

The volatility in headline growth masks a slowdown in underlying growth. Quarterly growth over 2019 as a whole is expected to average around 0.2%. That is lower than in the previous three years, when growth averaged around 0.4% a quarter (Chart 2.12). The slowdown in underlying growth is visible in the services sector, where quarterly growth was only 0.1% in Q2, the lowest rate in three years.

Chart 2.11 GDP growth has been volatile as a result of Brexit-related factors

Estimated contributions of various factors to quarterly GDP growth ^(a)

Sources: ONS and Bank calculations.

(a) Chained-volume measures. 2019 Q3 and Q4 are Bank staff projections. The contributions of idiosyncratic factors are estimated by Bank staff.
(b) GDP fell by 0.3% in December 2018 before rising by 0.5% in January 2019.

Chart 2.12 Abstracting from temporary factors, underlying growth has slowed

Quarterly GDP growth ^(a)

Sources: ONS and Bank calculations.

(a) Chained-volume measure. The hollow bars in 2019 Q3 and Q4 are Bank staff projections.

Surveys suggest that growth will remain weak in Q4.

Bank staff expect growth to fall back to 0.2% in Q4 (Chart 2.11). A wide range of survey indicators of output have weakened over the past year, consistent with a decline in underlying growth (Chart 2.13). Forward-looking surveys of expected output growth are even further below average (Chart 2.14). In isolation, these are consistent with negative GDP growth in Q4. However, the surveys have underestimated growth in recent quarters. This could be because the relationship between survey responses and growth may be weaker at times of high uncertainty, as discussed in Box 3 in the February Report. In particular, the elevated risk of a no-deal Brexit could have influenced some firms when they responded to the most recent surveys.

The slowdown in UK growth can be partly explained by Brexit…

Brexit-related uncertainties have weighed on UK GDP growth, as discussed in detail in Section 4. Much of this effect is via weaker demand, although it may also have affected the supply side of the economy (Section 2.3).

Chart 2.13 Survey indicators of output are weak

Survey indicators of current output growth ^(a)

Sources: BCC, CBI, IHS Markit/CIPS and Bank calculations.

(a) Differences from averages since January 2000 or earliest observation. The BCC series is a weighted average of home and export deliveries across the services and non-services sectors. Data are not seasonally adjusted. The CBI series is a weighted average of output volumes across the manufacturing, distribution, consumer, business and professional services sectors. The IHS/Markit CIPS series is a weighted average of business activity across the services, manufacturing and construction sectors.

Chart 2.14 Surveys of expected output are even weaker

Survey indicators of expected output growth ^(a)

Sources: BCC, CBI, IHS Markit/CIPS and Bank calculations.

(a) Differences from averages since January 2000 or earliest observation. The BCC series is a weighted average of turnover expectations across the services and non-services sectors. Data are not seasonally adjusted. The CBI series is a weighted average of output expectations across the manufacturing, distribution, consumer, business and professional services sectors. The IHS/Markit CIPS series is a weighted average of business activity expectations across the services and construction sectors and new orders from the manufacturing sector.

Investment by businesses has been particularly affected, falling in five of the past six quarters. The Bank’s Decision Maker Panel (DMP) Survey shows that firms that are more uncertain about Brexit have made larger cuts to investment since the EU referendum (Chart 4.7). Research using the survey suggests total business investment is around 11% lower as a result of Brexit (see Bloom et al (2019)). Consistent with that, business investment growth has been lower in the UK than in other G7 countries since the referendum, growing by only 0.4% compared to an average of 13% elsewhere (Chart 2.15).

UK exports may also have been reduced as a result of the Brexit process. Trade data have been volatile, in part because of cross-border stockbuilding before the original March deadline. But a range of surveys suggest that the demand for UK exports has weakened considerably over the past couple of years (Chart 2.16). Some Agency contacts have reported that foreign firms are reorienting supply chains away from the UK because of uncertainty about future trading arrangements (Box 3).

Chart 2.15 UK business investment growth has been weaker than in other advanced economies

G7 business investment

Sources: Eikon from Refinitiv, Japanese Cabinet Office, OECD, ONS, Oxford Economics, Statistics Canada, US Bureau of Economic Analysis and Bank calculations.

(a) Business investment is not an internationally recognised concept. This line is based on similar series derived from other countries’ National Accounts, weighted by GDP at PPP. Private sector business investment for Italy. Business investment minus residential structures for Canada. Non‑residential private investment for Japan and the US. Non‑government investment minus dwellings investment for France and Germany.
(b) Chained‑volume measure.

Chart 2.16 Survey indicators of export growth show a clear weakening in external demand

UK exports and survey indicators of export growth

Sources: Bank of England, BCC, CBI, IHS Markit/CIPS, Make UK, ONS and Bank calculations.

(a) Survey indicators are scaled to match the mean and variance of four‑quarter export growth since 2000 or earliest data point. Indicators include surveys from: the Bank’s Agents (manufacturing companies’ growth in production for overseas customers over the past three months); the BCC (export orders and deliveries); the CBI (average of manufacturing export orders, deliveries and order books relative to normal volumes); Make UK (average of manufacturing reported and expected export orders); and the IHS Markit/CIPS (manufacturing export orders). The BCC data are not seasonally adjusted.
(b) Chained-volume measure, excluding the impact of missing trader intra-community (MTIC) fraud.

…and partly by the weakening world economy.

The slowdown in global growth has also dampened UK growth by weighing on demand for UK exports. It is also likely to have reduced investment in the UK, in common with other countries over the past year (Chart 2.4). Section 3 discusses developments in the global economy in more detail.

Consumer spending growth has slowed…

Consumer spending appears to have been relatively resilient to the uncertainty around Brexit, although its growth has also slowed (Chart 2.17). In 2019 Q2 it grew by 0.3% — similar to the average rate since 2017, but lower than the average from 2013–15 of 0.6%. Timelier indicators of consumer spending suggest consumption continued to grow at a similar pace in Q3. Official data on retail sales growth have been strong in recent months (Chart 2.17), even though surveys of the retail sector have been relatively gloomy.

Low household interest rates have supported consumer spending. Mortgage rates and personal loan rates remain near historical lows, with the rates on some fixed-rate mortgages continuing to fall over the past few months (Table 2.B). Interest rates on credit cards have increased, although the effective rate paid by the average borrower has remained stable, in part because of the past lengthening of interest-free periods.

Chart 2.17 Consumption growth has eased, although retail sales growth has remained strong

Household consumption and retail sales ^(a)

(a) Chained-volume measures.
(b) Includes non-profit institutions serving households (NPISH).

Table 2.B Household lending rates remain low

Selected household lending rates ^(a)

(a) The Bank’s quoted rate series are weighted monthly average rates advertised by all UK banks and building societies with products meeting the specific criteria. Not seasonally adjusted. In February 2019 the method used to calculate these data was changed. View the article ‘Introduction of new Quoted Rates data’ for more information.

…and there are signs consumers are becoming more cautious.

The growth of spending on non-essential items^[1] has slowed over the past year, which could be consistent with increasing consumer caution. Households have also increased the proportion of income they save each quarter. Recently revised data show that the saving ratio increased from an average of 5% over 2017 to 7% in 2019 Q2. The household financial balance — which captures the difference between saving and investment — was revised up to a greater extent, partly as a result of changes to the accounting treatment of student loans.

Headline measures of consumer confidence remain close to their past averages, but expectations about the general economic situation have been below average, and declining, for some time. The GfK/EC October survey recorded the highest balance of people expecting unemployment to rise since 2013 (Chart 2.18).

Demand in the housing market remains subdued.

Households’ concerns about the economic situation are likely to help explain subdued demand in the housing market. Transaction and mortgage approvals figures have been broadly flat for around five years now. House price growth has also moderated across the UK since the EU referendum, and prices have fallen in London and the South East over the past year (Chart 2.19).^[2] Leading indicators of the housing market, including timelier but narrower measures of house prices, suggest UK house price inflation has stabilised just above zero. The lower rate of price inflation may be feeding through to house building: the number of private housing starts in England was around 10% lower in 2019 Q2 than a year earlier.

Chart 2.18 Households are pessimistic about the economy, although confidence in their own financial situation has held up

Indicators of consumer confidence ^(a)

Sources: GfK (research carried out on behalf of the European Commission) and Bank calculations.

(a) Differences from averages since 1997.
(b) Net balance of respondents expecting that the number of people unemployed will rise over the next 12 months.
(c) Net balances of respondents reporting that they expect their personal financial situation or the general economic situation to improve over the next 12 months.

Chart 2.19 UK house price inflation has slowed; prices in London and the South East have fallen

House price inflation by area ^(a)

Sources: HM Land Registry and Bank calculations.

(a) Percentage changes, three months on a year earlier. Data for Northern Ireland are available on a quarterly basis and are seasonally adjusted by Bank staff.

Higher government spending should continue to boost growth.

Government spending has been growing faster than expected recently. Central government spending in cash terms was around 5% higher in the fiscal year to September than the previous year — well above the Office for Budget Responsibility’s forecast from March. In the National Accounts, real government consumption in Q2 was 4% higher than a year ago — the fastest rate of growth since 2008. Government borrowing has been revised up over the recent past following changes to the accounting treatment of student loans and a correction to corporation tax receipts data.

Most recently, the Government announced a large increase in spending in September as part of Spending Round 2019. This included £2 billion of additional departmental spending in 2019–20 and £13 billion in 2020–21. All else equal, this is expected to raise GDP by around 0.4% over the MPC’s three-year forecast period.

2.3 Supply, costs and prices

The slowdown in underlying GDP growth might suggest there is emerging spare capacity.

GDP growth — at around 0.2% per quarter on average over 2019 — has now slowed to below the MPC’s estimate of potential growth in the medium term of between 0.3% and 0.4% a quarter. That estimate is based on an annual assessment of the supply side of the economy.^[3] The MPC judges that demand and supply were broadly in balance around the start of the year. Therefore, if supply growth has remained stable, a degree of spare capacity has probably opened up in the economy.

But supply growth may also have slowed.

Labour productivity, measured as output per hour worked, fell by 0.5% in the year to Q2, although it is expected to have recovered a little in Q3 (Chart 2.20). While productivity growth has been consistently weak since the financial crisis a decade ago, the fall in the year to Q2 was the biggest four-quarter fall since 2012. As discussed in previous Reports, much of the post-crisis weakness in productivity growth can be accounted for by the financial and manufacturing sectors. Productivity growth remained weak in those sectors in the latest data, but the decline over the past year reflects broader weakness (Chart 2.21). As well as reflecting weaker demand, it is possible that the weak productivity observed in the data has a structural supply-side element that has reduced potential supply growth. This would imply that less spare capacity has emerged than the fall in GDP growth might suggest in isolation.

Chart 2.20 Productivity has been weak since the crisis

Hourly labour productivity ^(a)

Sources: ONS and Bank calculations.

(a) Output is based on the backcast for the final estimate of GDP. Diamond shows Bank staff’s projection for 2019 Q3, based on data to August.

Chart 2.21 The slowdown in productivity growth over the past year has been broadly based

Contributions to four-quarter hourly labour productivity growth ^(a)

Sources: ONS and Bank calculations.

(a) Figures in parentheses are weights in nominal GVA. Weights do not sum to 100 due to rounding.

Brexit preparations could have dragged on productivity and supply growth.

The recent weakness in productivity growth could be a consequence of firms making Brexit preparations. The Bank’s DMP Survey shows that many firms are committing several hours a week of senior management time to Brexit planning (Chart 2.22). This could be reducing the time available to make sales or organise production, potentially detracting from output and productivity growth. Stockbuilding may also have tied up funds that would otherwise have been used for productivity-enhancing investments. Finally, Brexit may have reduced the growth of internationally exposed firms by more than domestically focused firms. As the former tend to be more productive, this effect would reduce average productivity. Research using the DMP Survey estimates that Brexit has reduced productivity by around 2% since the EU referendum. It may continue to weigh on output while uncertainty remains elevated.

Chart 2.22 Businesses have devoted more time to Brexit preparations, which may have reduced productivity growth

CFO time spent on Brexit ^(a)

Sources: Decision Maker Panel (DMP) Survey and Bank calculations.

(a) Question: ‘On average, how many hours a week is the CFO of your business spending on preparing for Brexit at the moment?’. The DMP currently consists of around 8,000 businesses with around 3,000 responses a month being received.

Chart 2.23 Most indicators of capacity utilisation have fallen over the past year

Survey indicators of capacity utilisation ^(a)

Sources: Bank of England, BCC, CBI, CBI/PwC, IHS Markit/CIPS, ONS and Bank calculations.

(a) Differences from averages between 2000 and 2007. Measures from the Bank’s Agents, the BCC (non-services and services), the CBI (manufacturing — capacity; financial services, business/consumer/professional services and distributive trade — business relative to normal) and IHS Markit/CIPS (manufacturing — backlogs; services — outstanding business). Sectors are weighted using shares in gross value added. The BCC data are not seasonally adjusted. The Agents’ data for 2019 Q4 are for October.

Some spare capacity may have emerged within firms…

The weakness of productivity could also reflect increasing spare capacity within firms. Most survey indicators suggest spare capacity has widened over the past year, and some imply that capacity utilisation is now below normal levels (Chart 2.23). However, some of these indicators can be volatile, and the mapping from them to capacity utilisation is uncertain.

…and although there appears to be little spare capacity in the labour market…

The unemployment rate increased slightly to 3.9% in the three months to August, but it remains at a historically low level. It is also below the MPC’s estimate of the equilibrium rate of unemployment — 4¼% — that would be consistent with inflation at the target in the medium term.

Broader measures of underemployment also suggest there is little spare capacity in the labour market. The average number of extra hours people would like to work has stabilised around zero, with full-timers wishing to work fewer hours almost exactly offsetting part-timers who wish to work longer hours (Chart 2.24). And the proportion of the population who report they would like a job but are not currently seeking one — the marginal attachment ratio — is also very low. That suggests there is little spare capacity among those not actively looking for a job.

The MPC judges that, while spare capacity has emerged in the UK economy, its degree is limited, and it is a little smaller than the slowing in GDP growth alone might suggest.

Chart 2.24 People no longer wish to work longer hours, on average

Net additional desired hours ^(a)

Sources: Labour Force Survey and Bank calculations.

(a) Number of net additional hours that the currently employed report they would like to work, on average, per week.

Chart 2.25 Employment has fallen in recent months

Decomposition of changes in employment ^(a)

(a) Three months on previous non-overlapping three months.
(b) Unpaid family workers and those on government-supported training and employment programmes classified as being in employment.

…there is mounting evidence of weakening demand for labour.

While the labour market remains tight, it no longer appears to be tightening. Employment growth has slowed over the past year, consistent with the weakening in underlying output growth. Employment actually fell in the three months to August (Chart 2.25). The weakness appears set to continue: surveys of hiring intentions have softened in recent months (Chart 2.26). And the number of vacancies in the economy has fallen by around 50,000 since the start of the year, the sharpest fall since 2009 — although the number of vacancies is still very high (Chart 2.27).

The tight labour market has caused pay growth to strengthen further…

Pay growth has increased steadily over the past few years as the labour market has tightened. Private sector regular pay growth was 4.0% in the three months to August, as high as it has been in over a decade (Chart 2.28). The strength in pay growth has been broadly based, with growth picking up in both the private and public sectors in recent years.

Chart 2.26 Surveys of hiring intentions have weakened

Employees and surveys of hiring intentions

Sources: Bank of England, IHS Markit/CIPS, KPMG/REC Report on Jobs, ONS and Bank calculations.

(a) Survey indicators are scaled to match the mean and variance of annual growth in employees since 2000. Indicators include surveys from: the Bank’s Agents (employment intentions over the next six months); IHS Markit/CIPS (PMI composite employment index); and KPMG/REC (index of demand for staff).

Chart 2.27 There has been a sharp fall in vacancies

Number of vacancies

Chart 2.28 Pay is growing at its fastest rate in over a decade

Measures of pay growth ^(a)

(a) Three-month average growth on the same period a year earlier.

Chart 2.29 Compositional effects have been pushing up pay growth

Estimates of the contribution of employment characteristics to four-quarter wage growth ^(a)

Sources: Labour Force Survey and Bank calculations.

(a) Estimates are shown relative to their averages over 1995–2010. Estimates of the effect of individual and job characteristics are derived from a regression of these characteristics on levels of pay. The estimate of the total compositional effect is obtained by combining these estimates with changes in the composition of the labour force.
(b) Other includes age, tenure, gender, region of residence, whether full-time and whether in public sector employment.

…but there are signs pay growth will moderate over the coming months.

A number of indicators suggest that pay pressures are no longer building, and pay growth may cool over the coming months (Table 2.D). The Bank’s settlements database suggests pay awards are clustering between 2% and 3%, slightly lower than a year ago. Surveys by the REC and the Bank’s Agents also suggest pay growth is stabilising a little below the pace of growth in the official data. It is possible that growth in the official pay figures has been temporarily boosted by the changing composition of the workforce. Employment has increased in higher paying occupations and industries, which will tend to increase average pay growth, but only as long as the compositional shift continues (Chart 2.29). Such effects on pay growth have tended not to persist in the past.

More broadly, underlying pay pressures may cool a little in coming quarters as the weakening in GDP growth and demand for labour reduce pressure on employers to raise pay.

Pay growth has increasingly outpaced productivity growth, causing unit labour cost growth to accelerate.

The impact of faster pay growth on firms’ costs has been compounded by weak productivity growth. This has caused the growth of unit labour costs (ULCs) — the cost of labour needed to produce one unit of output — to pick up (Chart 2.30). Measures of ULC growth now appear to be above the ranges judged to be consistent with inflation at the target.

A moderation of pay growth as a result of weaker demand would probably cause ULC growth to fall. But a moderation as a result of compositional effects fading may have less of an effect: the make-up of the workforce should have similar effects on pay and productivity, and hence have little effect on ULC growth.

Firms may have temporarily absorbed higher costs in their profit margins…

The Bank’s Agents report that firms in the consumer services sector have struggled to pass higher costs on to customers. That could explain why CPI-based measures of domestic price pressures still paint a somewhat weaker picture than labour cost-based measures.

…but measures of domestic price pressures based on consumer prices are picking up.

Nevertheless, CPI-based measures of domestic price pressures have been increasing recently, suggesting cost pressures have begun to feed through the supply chain. Core services price inflation increased to 2.5% in September, the highest rate in almost two years (red line in Chart 2.31). Excluding rents inflation — which has been unusually weak primarily because of restrictions on social housing rents — core services inflation increased to 2.9%. And the median services inflation rate — a measure of services price inflation less affected by volatility in individual items — has been increasing steadily since 2015 (blue line in Chart 2.31).

Chart 2.30 Unit labour cost growth has picked up as a result of strong pay and weak productivity growth

Contributions to four-quarter unit wage cost growth ^(a)

Sources: ONS and Bank calculations.

(a) Private sector AWE regular pay divided by private sector productivity per head, based on the backcast for the final estimate of private sector output. The diamond shows Bank staff’s projection for 2019 Q3. See Table 4.C in the November 2018 Inflation Report for more details on measures of unit labour costs.

Chart 2.31 Services prices suggest domestic price pressures have picked up a little

Core services and median services CPI inflation

Sources: ONS and Bank calculations.

(a) Core services CPI excludes airfares, package holidays, education and an estimate of the impact of changes in VAT.
(b) The median annual inflation rate of around 190 services items in the CPI basket.

CPI inflation has been close to the target recently…

Headline CPI inflation is determined by both domestic and external cost pressures. Inflation has been close to the 2% target in recent months: it averaged 1.8% over Q3, broadly in line with the August Inflation Report forecast (Chart 2.1). External cost pressures — such as energy prices and other import prices — are currently making a small contribution to inflation. Core inflation, which excludes the effects of energy prices and some other volatile components, was 1.7% in Q3.

…but will fall over the coming months as a result of lower energy prices.

CPI inflation is expected to average 1.4% in Q4. Most of the fall reflects a lower contribution to inflation from energy prices. In October Ofgem reduced the energy price caps affecting default and pre-payment tariffs. Electricity prices were cut by 3% and gas prices by 9% for the typical default tariff customer. As a result, household energy bills are expected to drag on inflation in Q4 (Chart 2.32).

Fuel prices are also expected to pull down inflation over the next few months. Sterling oil prices are almost 10% lower than at the time of the August Report and over 20% lower than a year ago. Altogether, the contribution to CPI inflation from energy prices is expected to fall from around 0.2 percentage points in Q3 to -0.2 percentage points in Q4.

Regulated prices will pull inflation even lower in 2020.

A number of other regulated prices are likely to affect inflation over the coming year. Water bills are expected to fall in April as a result of action by the regulator Ofwat. That will be offset partially by an increase in the social housing rents cap. These changes, in addition to a further drag from energy prices from April, are expected to result in inflation falling to 1.2% in 2020 Q2 (Section 1). Core inflation is expected to remain closer to the target, at around 1.5%.

Cheaper imports will also pull down inflation.

CPI inflation is also sensitive to import prices, which are heavily influenced by the exchange rate. Import price inflation has been subdued over the past year, following high rates over 2016 and 2017 after sterling’s referendum-related decline (Chart 2.33). Sterling has appreciated by 4% since the August Report. If sustained, that will lead to lower import prices over the coming year and pull down CPI inflation.

Chart 2.32 Energy prices are expected to fall in Q4, pulling inflation down

Contributions to CPI inflation ^(a)

Sources: Bloomberg Finance L.P., Department for Business, Energy and Industrial Strategy, ONS and Bank calculations.

(a) Contributions to annual CPI inflation. Figures in parentheses are CPI basket weights in 2019.
(b) Bank staff’s projection. Fuels and lubricants estimates use Department for Business, Energy and Industrial Strategy petrol price data for October 2019 and are then based on the sterling oil futures curve.
(c) The difference between CPI inflation and the other contributions identified in the chart.

Chart 2.33 Import price inflation was close to zero in the year to 2019 Q2

Import price and foreign export price inflation ^(a)

Sources: Bank of England, CEIC, Eikon from Refinitiv, Eurostat, ONS and Bank calculations.

(a) The diamonds show Bank staff’s projections for 2019 Q3.
(b) Domestic currency export prices as defined in footnote (d), divided by the sterling effective exchange rate index.
(c) UK goods and services import deflator excluding fuels and the impact of MTIC fraud.
(d) Domestic currency non-oil export prices of goods and services of 51 countries weighted according to their shares in UK imports. The sample excludes major oil exporters.

Brexit may have put upward pressure on short-term inflation expectations.

Measures of households’ expectations for inflation in one and two years’ time increased slightly in Q3 (Table 2.C) and are above their post-crisis averages. It is unusual for short-term inflation expectations to increase while the actual inflation rate has been falling (Chart 2.34). This could be happening now because households are expecting Brexit to increase prices. In the latest Inflation Attitudes Survey, 50% of respondents reported that Brexit had raised their expectation for inflation in one year’s time, compared with 10% of respondents who said it had lowered their expectation.

Short-term inflation expectations derived from financial market indicators also increased over Q3, although they fell back at the start of Q4 (Table 2.C). Market contacts attribute much of the movement to changing expectations about Brexit and associated expectations for the exchange rate.

Long-term expectations appear stable, although financial market measures have become harder to interpret.

Measures of households’ long-term expectations fell or remained stable in Q3, and are close to their post-crisis averages (Table 2.C). Implied expectations for RPI inflation in financial markets at longer horizons have also fallen (Chart 2.35). There have been similar falls in the US and euro area, suggesting there may be an international factor behind the move. Some of the fall could also be in response to the UK Statistics Authority’s recently announced plan to bring the method of calculating RPI into line with that used for CPIH, which would lower RPI inflation. The exact date for the change is uncertain: the Chancellor has announced his intention to consult on whether to allow the change to take effect between 2025 and 2030. This uncertainty makes interpreting the signal from these measures more difficult.

Overall, the MPC judges that indicators of inflation expectations are consistent with inflation close to the 2% target.

Chart 2.34 Households’ short-term inflation expectations have drifted up over the past year, despite inflation falling

Measures of households’ one year ahead inflation expectations and CPI inflation ^(a)

Sources: Bank of England, Citigroup, TNS, YouGov and Bank calculations.

(a) Quarterly data. Final YouGov/Citigroup data point is for October only. Data are not seasonally adjusted.

Chart 2.35 Long-term expectations of RPI inflation have fallen

Implied expectations of RPI inflation from swaps ^(a)

Sources: Bloomberg Finance L.P. and Bank calculations.

(a) Instantaneous RPI inflation expectations implied by swaps.
(b) October 2019 is an average to 30 October.

Table 2.C The MPC judges that inflation expectations remain anchored

Indicators of inflation expectations ^(a)

Sources: Bank of England, Barclays Capital, Bloomberg Finance L.P., CBI, Citigroup, ONS, TNS, YouGov and Bank calculations.

(a) Data are not seasonally adjusted.
(b) Averages from 2000, or start of series, to 2007. Financial market data start in October 2004, YouGov/Citigroup data start in November 2005 and professional forecasters data start in 2006 Q2.
(c) Financial market data are averages to 30 October 2019. YouGov/Citigroup data are for October.
(d) The household surveys ask about expected changes in prices but do not reference a specific price index. The measures are based on the median estimated price change.
(e) CBI data for the distributive trades sector. Companies are asked about the expected percentage price change over the coming 12 months and the following 12 months in the markets in which they compete.
(f) Instantaneous RPI inflation one and three years ahead and five-year RPI inflation five years ahead, implied from swaps.
(g) Bank’s survey of external forecasters, CPI inflation rate three years ahead.

Table 2.D Monitoring the near-term outlook ^(a)

Sources: Bank of England, Bloomberg Finance L.P., Department for Business, Energy and Industrial Strategy, Eurostat, IMF World Economic Outlook (WEO), ONS, US Bureau of Economic Analysis and Bank calculations.

(a) Definitions of underlying series are as given in footnotes of Table 1.C in Section 1, unless otherwise stated. Figures show quarterly growth rates unless otherwise stated. All price and wage measures are four-quarter growth rates.
(b) Data are projections unless otherwise stated.
(c) Data for 2019 Q3 is an outturn.
(d) Projections based upon official data to August 2019.
(e) Quarterly level.
(f) Whole-economy regular pay. Growth rates based on KAI7.