Global economic and financial market developments
The outlook for the global economy has improved in recent quarters, as growth has picked up and its composition has rotated towards investment. The improving outlook, alongside greater investor risk appetite, has supported rises in equity and corporate bond prices over the past year. Financial market prices imply that UK and euro-area policy rates are expected to rise more quickly than they had been in May, although the pace remains gradual. Sterling’s exchange rate has fallen slightly since May and remains significantly below its level prior to the EU referendum.
Demand and output
Output growth slowed in the first half of 2017. Much of that slowing appears to have been driven by weaker growth in household spending, as sterling’s depreciation weighed on real income growth. Net trade has been volatile, but the depreciation and the strength in global demand are expected to provide support. Business investment growth has picked up a little and, together with net trade, is projected to offset part of the weakness from household spending.
Supply and the labour market
Growth in companies’ demand for labour appears to have remained resilient in recent months, with quarterly employment growth picking up in 2017 H1. Despite a further fall in unemployment, wage growth remains subdued, probably in part due to continued weak productivity growth. Wage growth is projected to remain modest in the near term, before recovering somewhat further ahead reflecting underlying tightness in the labour market.
Costs and prices
Although CPI inflation has been volatile, it has risen over 2017 and was 2.6% in June. It is expected to remain around 2¾% in the near term, boosted by higher import prices as a result of the depreciation in sterling, before easing back towards the 2% target during 2018. Growth in firms’ imported costs appears to have started moderating. Domestically generated inflation appears to have remained relatively subdued and inflation expectations remain consistent with the MPC’s 2% target.
Prospects for inflation
CPI inflation has remained above the 2% target as rises in import prices following the steep fall in the sterling exchange rate last year continue to pass through to consumer prices. That has weighed on households’ real incomes and consumption, contributing to the slowdown in GDP growth in the first half of 2017. Over the forecast period, growth in real income and consumption is projected to remain subdued. The effect of that on overall GDP growth is offset to some extent by UK exports and investment, which are supported by strong growth in the rest of the world and the lower exchange rate. Overall, given a market-implied path for Bank Rate that rises by around ½ percentage point over the next three years, growth is projected to be modest and unemployment to stay close to its current rate. Import price pressures begin to fade in the second half of the forecast period, but are still keeping inflation above the 2% target at the end. On the market path for Bank Rate, the small degree of slack remaining in the economy is absorbed and domestic inflationary pressures are judged likely to increase over the forecast period.