Monetary Policy Summary
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The Bank of England’s Monetary Policy Committee (MPC) sets monetary policy in order to meet the 2% inflation target and in a way that helps to sustain growth and employment. At its meeting ending on 4 November 2015, the MPC voted by a majority of 8-1 to maintain Bank Rate at 0.5%. The Committee voted unanimously to maintain the stock of purchased assets financed by the issuance of central bank reserves at £375 billion, and so to reinvest the £6.3 billion of cash flows associated with the redemption of the December 2015 gilt held in the Asset Purchase Facility.
In September, twelve-month CPI inflation stood at -0.1%, slightly over 2 percentage points below the inflation target. Around four fifths of the deviation from the target reflects falls in energy, food and other imported goods prices, with the remainder reflecting subdued domestic cost growth. The combined weakness in domestic costs and imported goods prices is evident in subdued measures of core inflation, which are currently around 1%.
The outlook for inflation reflects the balance between persistent drags from factors such as sterling and world export prices, and prospective further increases in domestic cost growth. The MPC’s objective is to return inflation to target sustainably; that is, without an overshoot once persistent disinflationary forces ultimately wane. 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.
The outlook for global growth has weakened since the August Inflation Report. Many emerging market economies have slowed markedly and the Committee has downgraded its assessment of their medium-term growth prospects. While growth in advanced economies has continued and broadened, the Committee nonetheless expects the overall pace of UK-weighted global growth to be more modest than had been expected in August. There remain downside risks to this outlook, including that of a more abrupt slowdown in emerging economies.
Domestic momentum remains resilient. Consumer confidence is firm, real income growth this year is expected to be the strongest since the crisis, and investment intentions remain robust. As a result, domestic demand growth has been solid despite the fiscal consolidation. Although it has moderated, growth is projected to pick up a little towards the middle of next year, as a tighter labour market and stronger productivity support real incomes and consumption, and as accommodative credit conditions encourage strong investment and a pickup in the housing market. The Committee judges the risks to domestic demand to be broadly balanced.
Robust private domestic demand is expected to produce sufficient momentum to eliminate the margin of spare capacity over the next year. Domestic cost pressures are expected to build as a result of a pickup in wage growth relative to productivity growth. CPI inflation is nonetheless expected to remain below 1% until the second half of next year, reflecting the continuing drag from commodity and other imported goods prices. Beyond that, the dampening influence of sterling’s past appreciation on inflation is expected to be persistent, diminishing only slowly over the MPC’s forecast period. In this context, the MPC judges it appropriate to return inflation to the target in around two years.
Reflecting concerns about the global outlook, prices of risky assets have fallen since August. There have also been sizable declines in the yields on safe assets. These have had opposing effects in the forecast. The path for Bank Rate implied by market yields, on which the MPC’s projections are conditioned, has fallen and now embodies an even more gradual pace of tightening than at the time of the previous Report.
In the Committee’s judgement, the lower path for Bank Rate implied by market yields would provide more than adequate support to domestic demand to bring inflation to target even in the face of global weakness. In that case, the MPC’s best collective judgement is for the most likely path for inflation to exceed slightly the 2% target in two years and then rise a little further above it, reflecting modest excess demand. The MPC judges that the risks to this projection lie slightly to the downside in the first two years, reflecting global factors.
Underlying those projections are significant judgements in a number of areas, as described in the November Inflation Report. In any one of these areas, developments might easily turn out differently than assumed, with implications for the outlook for growth and inflation, and therefore for the appropriate stance of monetary policy. Reflecting that, there is a range of views among MPC members about the balance of risks to inflation relative to the best collective judgement presented in the November Report. At the Committee’s meeting ending on 4 November, the majority of MPC members judged it appropriate to leave the stance of monetary policy unchanged at present. Ian McCafferty preferred to increase Bank Rate by 25 basis points, given his view that the path of domestic costs was more likely to lead to inflation exceeding the target in the medium term than was embodied in the Committee’s collective November projections.
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.