Global economic and financial developments
Since the November Report, the ECB has eased policy further and the FOMC has raised interest rates. In the United Kingdom, the market-implied path for Bank Rate is lower than that in the run-up to the November Report and the sterling ERI has depreciated by 3½%. Oil prices have fallen substantially since November, to around US$29 per barrel. Financial market volatility rose and UK equity prices fell significantly, alongside those in the United States and the euro area. UK-weighted world GDP growth remained subdued in 2015 Q3, in line with expectations in November.
Demand and output
In 2015, four-quarter GDP growth slowed from a little above to a little below its historical average rate. Although a slowing was anticipated, growth has been slightly softer than expected. In the near term, private domestic demand growth is projected to remain resilient in the face of subdued global growth and continued fiscal consolidation, supported by the past easing in credit conditions and continued solid real income growth.
Supply and the labour market
Employment has grown at a strong pace and the unemployment rate has declined further over the past year, to 5.1% in the three months to November. Despite this, nominal wage growth has softened in recent months. There appear to be a number of factors temporarily weighing on wage growth, including continuing shifts in the composition of employment and possibly low headline inflation. Productivity growth also slowed in Q4, but four-quarter growth remains stronger than in recent years.
Costs and prices
CPI inflation picked up to 0.2% in December, as the past falls in energy prices began to drop out of the annual comparison and core inflation strengthened. Inflation is projected to increase further in the coming months but a little less quickly than anticipated in November, largely reflecting recent falls in oil prices. The depreciation of sterling, however, should mean the drag from import prices fades a little more rapidly than previously projected. Four-quarter unit labour cost growth probably fell to 1.4% in Q4 but is projected to strengthen over 2016, reducing the drag on CPI inflation from subdued domestic costs. Inflation expectations remain broadly consistent with the MPC’s 2% target.
Prospects for inflation
CPI inflation has begun to rise, but remains close to zero due primarily to falls in the prices of energy, food and other imported goods prices. Following a period of above-average growth, four-quarter GDP growth has slowed by slightly more than expected. The prices of risky assets have fallen since the November Report and oil prices, the sterling exchange rate and the yield curve are lower. In the MPC’s central projection, conditioned on Bank Rate rising very gradually, four-quarter GDP growth rises back to around 2½%. Although CPI inflation is likely to remain low in the near term, once the temporary drag from energy and other imported goods prices has faded, strengthening domestic cost growth is projected to take inflation back to the 2% target in around two years and then slightly above it.