Prospects for inflation

Section 5 of the Inflation Report - February 2018

Inflation was 3.1% in November, triggering an exchange of letters between the Governor and the Chancellor. The current overshoot of inflation above the 2% target is almost entirely due to the effects of higher import prices following sterling's depreciation, the contribution from which will dissipate in coming years. UK GDP growth is projected to remain around its current pace, a slightly stronger near-term outlook than in November, supported by strengthening global growth. While modest by historical standards, that pace of UK growth is more than sufficient to use up the limited slack remaining in the economy. Under a conditioning path that embodies just under three further 25 basis point rises in Bank Rate over the next three years, a small margin of excess demand emerges by early 2020 and builds thereafter. Inflation remains above the target as domestic inflationary pressures continue to firm.

The MPC voted in November to raise Bank Rate to 0.5%. That is feeding through into higher interest rates for companies and households in line with past experience (see Box 2). The MPC's projections are conditioned on a market-implied path for Bank Rate that is around 15 basis points higher than in November. That path implies a gradual further rise in Bank Rate to just under 1.2% at the start of 2021 (Table 5.A).1

The broad-based pickup in global growth has strengthened further, with global growth at its fastest pace in seven years and above-trend growth in 90% of the world economy. Healthy business and consumer confidence, and supportive financial conditions, mean the current pace of global growth is likely to persist at least throughout 2018 (Key Judgement 1). That is stronger than projected in November and the risks around the outlook for global growth are to the upside.

UK GDP growth was stronger than expected in Q4, although still modest by historical standards (Section 2). The strength in global growth is supporting net trade and business investment. The anticipation of and uncertainty around Brexit, however, appear to be weighing on investment, and the associated fall in sterling's exchange rate is squeezing households' real incomes and dampening consumption growth (Key Judgement 2). In the run-up to this Report, the sterling ERI was 3% higher than at the time of the November Report, though 16% below the peak in late 2015. As in previous Reports, the MPC's projections are conditioned on the average of a range of possible outcomes for the UK's eventual trading relationship with the EU. The projections also assume that, in the interim, households and companies base their decisions on the expectation of a smooth adjustment to that new trading arrangement.

Under those assumptions, four-quarter GDP growth is projected to average around 1¾% (Table 5.B), supported by the strength in global growth, a lessening drag from the fiscal consolidation, accommodative financial conditions and a modest recovery in household real income growth. The risks to the central outlook are skewed to the upside (Chart 5.1), stemming from the possibility of a greater boost from global demand.

Following its annual reassessment of supply-side conditions, the MPC judges that spare capacity has been further absorbed and that very little remains, despite a small downward adjustment in the Committee's judgement of the equilibrium unemployment rate. Furthermore, and notwithstanding a projected rise in structural productivity growth, overall potential supply growth is likely to remain modest by historical standards (Key Judgement 3). As a result, the pace of demand growth consistent with balanced domestic inflationary pressures is judged to be around 1½%, much slower than pre-crisis norms.

In the MPC's projections, the stronger pace of demand growth is sufficient to absorb the limited degree of spare capacity sooner than in the November projections, with the economy moving into excess demand by early 2020. That leads to a steady firming of domestic inflationary pressures (Key Judgement 4), albeit from rates below those consistent with the 2% target. There are signs of tightening in the labour market as unemployment has fallen, surveys suggest increasing recruitment difficulties and pay growth is beginning to rise in response (Section 4). In the central projection, unemployment falls a little further (Chart 5.2) and rising growth in pay outstrips that of productivity. That supports somewhat firmer growth of unit labour costs and rising domestic cost pressures more broadly.

Inflation is currently a percentage point above the MPC's 2% target, almost entirely due to the effects of higher import prices following sterling's depreciation. Those effects will diminish gradually in coming years. More recently, the rise in global oil prices has added somewhat to external cost pressures. Under the market path for interest rates prevailing at the time the forecast was finalised,1 domestic inflationary pressures firm while the contribution from energy and import prices dissipates. The balance of these effects means that inflation falls gradually but remains above the target in the second and third years of the forecast period (Chart 5.3).

At its meeting ending on 7 February 2018, the MPC voted to maintain Bank Rate at 0.5%, to maintain the stock of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, at £10 billion and to maintain the stock of UK government bond purchases, financed by the issuance of central bank reserves, at £435 billion. The factors behind that decision are set out in the Monetary Policy Summary on pages i–ii of this Report, and in more detail in the Minutes of the meeting. The remainder of this section sets out the MPC's projections, and the risks around them, in more detail.

5.1    The MPC's key judgements and risks

Key Judgement 1: the broad-based strength in global growth continues

Growth has picked up significantly across many economies over the past two years. The outlook for global growth appears to have strengthened somewhat further over the past three months. The current pace of quarterly growth is judged likely to persist at least over 2018, a stronger projection than in November (Chart 5.5).

In the euro area, above-trend growth has been supported by the accommodative stance of monetary policy, an easing in credit conditions, and reduced fiscal drag, alongside a steady rise in business and consumer confidence. Unemployment has fallen further, to its lowest level since 2009, though a significant degree of slack still appears to remain. These factors are projected to support continued above-trend annual average growth in 2018 at around 2¾%, compared with a projection of 2¼% in November.

In the United States, growth has also been robust in recent quarters. The tax cuts announced at the end of 2017 are likely to provide a greater and more immediate stimulus to spending than anticipated in November. That, combined with supportive financial conditions (Section 1), suggests a continuation of the current strong pace of quarterly growth in 2018 at around ¾%. Annual average growth is projected to accelerate to 3% in 2018, compared with a central forecast of 2¼% in the November projections.

Strengthening advanced-economy growth, alongside stable growth in China and improving outlooks in other emerging market economies, has led to a rise in some commodity prices. Oil and industrial metals prices have risen to their highest levels in several years. That will feed through into higher headline inflation rates in many countries in coming months and contribute to higher global export prices.

Based on PPP weights, global activity is projected to expand at an annual average rate of just over 4% in 2018 before slowing to 3½% by 2020 (Table 5.C) as remaining slack is absorbed and global inflationary pressures build. Weighted by UK export shares, growth is around 3% in 2018, slowing to 2¼% by 2020. It is possible that the current momentum in global growth could persist for longer than embodied in the central projection. To the extent that it is matched by stronger global productivity growth, and hence a faster pace of supply growth, it would be unlikely to lead to additional global inflationary pressure.

Key Judgement 2: the rotation in UK GDP growth away from domestic consumption and towards external demand and investment continues

In contrast to the strengthening in global growth, UK growth has remained modest by historical standards. It picked up in Q4 and was stronger than expected (Section 2). Four-quarter GDP growth is projected to average around 1¾% over the forecast period (Chart 5.1), supported by strong global growth (Key Judgement 1) and a lessening drag from the fiscal consolidation following the measures announced in the November Budget. That is a slightly stronger near-term outlook than in November (Table 5.B).

Brexit is affecting both the level and composition of UK demand. The fall in sterling's exchange rate since late 2015 reflects financial market participants' judgements about the likely impact of Brexit on the United Kingdom's prospects. That fall has boosted consumer prices (Key Judgement 4) and depressed households' real incomes and spending. Households typically adjust their spending only gradually to changes in real income. While real income has fallen over the past year, four-quarter consumption growth has remained positive, slowing to around 1%, and the saving ratio has fallen.

Consumption growth is projected to remain subdued but stable over the next three years (Table 5.D), broadly in line with aggregate income growth such that the saving ratio remains broadly unchanged (Chart 5.6). Although the past fall in real income will continue to weigh on consumption, there are a number of factors supporting the current pace of growth. The contribution of import prices to inflation has probably peaked (Key Judgement 4). That, combined with a rise in nominal pay growth, will support some recovery in household real income growth (Table 5.E). Consumer confidence is only a little below past averages. Housing market activity slowed slightly in Q4, which combined with the recent fall in new housing starts is likely to drag on growth in housing investment in 2018 (Section 2).

In contrast to the weakness in consumption growth, net trade is expected to have made a significant positive contribution to GDP growth in 2017, supported by the strength in world demand and the past depreciation of sterling. Strong world demand, a low cost of capital, the high rates of return on capital and diminishing spare capacity have all supported business investment. Nevertheless, the drag from uncertainty around Brexit (see Box 3) has meant that investment growth has been notably weaker than in previous expansions.

In the central projection, the more persistent strength in global demand (Key Judgement 1) supports net trade, which continues to provide a significant boost to GDP growth (Table 5.C). That, in turn, leads to a gradual narrowing in the current account deficit to around 3¾% of GDP by the end of the forecast period. Alongside that, business investment growth picks up, also supported by global demand and intensifying capacity pressures. The outlook for business investment will remain sensitive to developments in and companies' perceptions of the United Kingdom's future trading arrangements.

The risks around the projection for GDP growth are skewed to the upside, stemming from the upside risks to global growth. The recent momentum in global growth may persist for longer than in the central projection (Key Judgement 1), and the boost to demand for UK goods and services from global demand could prove greater than anticipated.

Key Judgement 3: very little slack remains and the pace of potential supply growth is modest

The speed at which demand can grow before it puts upward pressure on inflation depends on the degree of spare capacity in the economy and on the rate of growth of potential supply. In recent years, elevated unemployment meant there was a significant degree of slack in the economy and demand could grow more quickly than potential supply without generating inflationary pressures. As unemployment has fallen and slack has been absorbed, the pace at which demand can grow has become increasingly dependent on the pace of potential supply growth.

In the run-up to this Report, the MPC completed its annual reassessment of supply-side conditions. The MPC judges that very little spare capacity remains. A range of evidence suggests that unemployment is close to its long-term equilibrium rate, which is now estimated to be 4¼%, slightly lower than estimated a year ago (see Box 4). Within companies, there appears to be some scope to increase output by raising the average number of hours worked by employees, but indicators suggest there is little capacity for companies to work their other resources more intensively (Section 3).

The MPC continues to judge that growth in potential supply will remain modest, relative to pre-crisis norms, at around 1½%. An important contributor to potential supply growth in recent decades has been population growth, which has been driven by strong net inward migration flows. Net inward migration has slowed over the past 18 months and, under the ONS's population projections on which the MPC's forecasts are conditioned, net migration slows slightly further in coming years. There is a risk that net migration will slow more sharply, however, reducing potential supply growth more materially (see Box 5).

Prior to the financial crisis, productivity growth was the largest driver of potential supply growth. In common with many other advanced economies, productivity growth in the UK has been persistently weak in recent years. Part of that global weakness is likely to reflect weak investment, which fell during the crisis and has only recovered gradually since then. As such, growth in the capital stock — the resources and equipment available for workers to produce output and a key driver of productivity — has been subdued. The weakness in productivity growth also appears to reflect weak growth in total factor productivity (TFP) — the efficiency with which companies use their labour and capital to produce output. The expansion in global trade and broadening of supply chains in the decade prior to the crisis is likely to have been one factor contributing to robust TFP growth during that period. Since then, growth in global trade and TFP have both been subdued.

Structural productivity growth is projected to pick up to just over 1% in 2019–20, broadly unchanged from the November projections. While that represents a pickup from the pace of productivity growth since the financial crisis, it is still around half the pre-crisis rate. Companies' anticipation of and response to post-Brexit trading relationships are likely to weigh on UK productivity growth. Uncertainty around Brexit appears to be holding back some investment (see Box 3) and any reduction in openness is also likely to weigh on TFP growth (Section 3). As explained in Box 6, although there has been little change to the MPC's judgement about the outlook for structural productivity growth, the profile for actual output per hour worked is lower than in the November projections (Table 5.C). Limited scope for companies to work their capital more intensively (Section 3) means output per hour worked now grows broadly in line with structural productivity.

There are significant risks in both directions to the outlook for productivity. Productivity growth has serially disappointed over the past decade and, in common with other forecasters, the MPC has marked down its forecasts numerous times. As such, it could fail to pick up by even the modest amounts assumed. Set against that, productivity, although volatile, has tended to grow by around 2% on average for many decades. Productivity could ultimately pick up by more than expected, particularly if there is a global upswing in trade and investment that benefits the United Kingdom.

Key Judgement 4: with demand outstripping potential supply, domestic inflationary pressures continue to build while the contribution from energy and import prices dissipates

At 3% in December, inflation remains above the MPC's 2% target, and the 3.1% outturn in November necessitated an exchange of letters between the Governor and the Chancellor, published alongside this Report. That overshoot was almost entirely due to the effects of higher import prices as a result of the past depreciation in sterling, though the recent rise in oil prices has also contributed. And it is possible that inflation could rise back above 3% temporarily.

Increases in global oil prices (Key Judgement 1) tend to be passed on to higher fuel prices quite quickly. The MPC's projections are conditioned on spot oil prices following the market futures curve, which is currently downward sloping (Table 5.C). The implied easing back in oil prices means that energy prices are weighing on inflation from the end of 2018.

The rise in non-energy import prices due to the depreciation in sterling will take several years to be passed on to consumer prices. Import prices have so far risen by slightly less than anticipated, given past experience (Section 4). Over the forecast period, import prices are assumed to make up that shortfall (Chart 5.7). Although the contribution from import prices to CPI inflation is likely to have peaked, import prices are projected to continue to push up inflation by around ½ percentage point over 2019 before that contribution diminishes further. Import prices are still pushing up inflation at the end of the three-year forecast period, but the recent appreciation of sterling means they contribute slightly less than projected in November, at just under ¼ percentage point.

There is a risk, however, that the contribution from import prices to inflation diminishes more rapidly than in the central projection. The more time that passes since the depreciation, the less likely it is that the shortfall in import prices relative to the size of the depreciation will be made up, and the greater the risk that import prices contribute slightly less to inflation over the forecast period.

As the effects from import and energy prices dissipate, inflation is supported by rising domestic inflationary pressures. The largest domestic component of companies' costs is labour. Although annual pay growth has been relatively subdued in recent years, it picked up by more than expected towards the end of 2017 and shorter-term measures suggest a further marked rise in annual pay growth in 2018 Q1 (Section 4). Indicators, including the recent Agents' annual pay survey, suggest pay growth is rising in response to the past tightening in the labour market and greater recruitment difficulties. The outlook for pay growth is stronger than in November (Table 5.D).

What matters for companies' costs is how fast pay grows relative to productivity — in other words, growth in their unit labour costs (ULCs). As productivity growth has been weak, unit labour cost growth has been much less subdued than pay growth. In the central projection, with unemployment falling slightly further (Chart 5.2), pay growth picks up, continuing to outstrip rising productivity growth (Key Judgement 3), and supporting somewhat firmer ULC growth (Table 5.C). There is a risk, however, that building pressure in the labour market leads to a more marked rise in pay and ULC growth over the forecast period.

The stronger outlook for demand growth (Key Judgement 2) coupled with modest potential supply growth (Key Judgement 3), means that the limited remaining degree of spare capacity in the economy is absorbed more quickly than in the November projections. In the central projection, under a conditioning path that embodies just under three further 25 basis point rises in Bank Rate over the next three years, a small margin of excess demand emerges by early 2020 and builds thereafter. Domestic inflationary pressures firm while the contribution from energy and import prices dissipates, and inflation remains above the target in the second and third years of the forecast period (Table 5.F).

5.2    The projections for demand, unemployment and inflation

Based on the judgements above and the risks around them, under the market path for Bank Rate and the assumption of an unchanged stock of purchased assets, the MPC projects four-quarter GDP growth to average around 1¾% over the next three years (Table 5.B). That projection is slightly stronger in the near term than in November (Chart 5.8). Consumption growth is projected to remain subdued relative to historical norms, partially offset by a positive contribution from net trade and a pickup in investment growth. The risks around the central projection are judged to lie to the upside (Table 5.G), stemming from the possibility of a greater boost from global demand.

The economy's potential supply capacity is projected to grow at a modest pace over the forecast period, lower than historical norms. There is judged to be only a very small degree of slack at the start of the forecast period. With demand growing faster than potential supply, that slack is fully absorbed and the economy moves into excess demand by early 2020. Unemployment is projected to fall slightly further (Chart 5.2), below its equilibrium rate.

Inflation is currently above the MPC's 2% target due to the effect of higher import prices following sterling's depreciation. While the contribution from energy weighs on inflation from the end of 2018, higher import prices are judged likely to push up inflation throughout the forecast period albeit to a diminishing degree. As those external price pressures wane, domestic inflationary pressures continue to build and, under the market path for Bank Rate, inflation is judged likely to remain above the 2% target in the second and third years of the forecast period (Chart 5.9). The risks around that projection are judged to be balanced (Chart 5.10).

Chart 5.11 and Chart 5.12 show the MPC's projections under the alternative constant rate assumption and an unchanged stock of purchased assets. That assumption holds Bank Rate at 0.5% throughout the three years of the forecast period, before it rises towards the market path over the subsequent three years. Under that path, GDP growth is stronger and inflation ends the forecast period further above the target.

  • Notes

    1. Unless otherwise stated, the projections shown in this section are conditioned on: Bank Rate following the path implied by market yields on average in the 15 working days to 31 January; the stock of purchased gilts remaining at £435 billion and the stock of purchased corporate bonds remaining at £10 billion throughout the forecast period and the Term Funding Scheme (TFS), all three of which are financed by the issuance of central bank reserves; the Recommendations of the Financial Policy Committee and the current regulatory plans of the Prudential Regulation Authority; the Government's tax and spending plans as set out in the 2017 November Budget; commodity prices following market paths; and the sterling exchange rate remaining broadly flat. For more details see the 'Data from the February 2018 Inflation Report'.

Table 5.A

Conditioning path for Bank Rate implied by forward market interest rates (a)

Table 5.A

  • Notes
    (a) The data are fifteen working day averages of one-day forward rates to 31 January 2018 and 25 October 2017 respectively. The curve is based on overnight index swap rates.
    (b) February figure for 2018 Q1 is an average of realised overnight rates to 31 January 2018, and forward rates thereafter.

Table 5.B

Forecast summary (a)(b)

Table 5.B

  • Notes
    (a) Modal projections for GDP, CPI inflation and LFS unemployment. Figures in parentheses show the corresponding projections in the November 2017 Inflation Report. Projections were only available to 2020 Q4 in November.
    (b) The February projections have been conditioned on the assumptions that the stock of purchased gilts remains at £435 billion and the stock of purchased corporate bonds remains at £10 billion throughout the forecast period, and on the Term Funding Scheme (TFS); all three of which are financed by the issuance of central bank reserves. The November projections were conditioned on the same asset purchase and TFS assumptions.
    (c) Four-quarter growth in real GDP. The MPC's projections are based on its backcast for GDP.
    (d) Four-quarter inflation rate.
    (e) Per cent. The path for Bank Rate implied by forward market interest rates. The curves are based on overnight index swap rates.

Chart 5.1

GDP projection based on market interest rate expectations, other policy measures as announced

Chart 5.1

  • Notes
    The fan chart depicts the probability of various outcomes for GDP growth. It has been conditioned on the assumptions in Table 5.B footnote (b). To the left of the vertical dashed line, the distribution reflects the likelihood of revisions to the data over the past; to the right, it reflects uncertainty over the evolution of GDP growth in the future. If economic circumstances identical to today's were to prevail on 100 occasions, the MPC's best collective judgement is that the mature estimate of GDP growth would lie within the darkest central band on only 30 of those occasions. The fan chart is constructed so that outturns are also expected to lie within each pair of the lighter green areas on 30 occasions. In any particular quarter of the forecast period, GDP growth is therefore expected to lie somewhere within the fan on 90 out of 100 occasions. And on the remaining 10 out of 100 occasions GDP growth can fall anywhere outside the green area of the fan chart. Over the forecast period, this has been depicted by the light grey background. See the box on page 39 of the November 2007 Inflation Report for a fuller description of the fan chart and what it represents.

Chart 5.2

Unemployment projection based on market interest rate expectations, other policy measures as announced

Chart 5.2

  • Notes
    The fan chart depicts the probability of various outcomes for LFS unemployment. It has been conditioned on the assumptions in Table 5.B footnote (b). The coloured bands have the same interpretation as in Chart 5.1, and portray 90% of the probability distribution. The calibration of this fan chart takes account of the likely path dependency of the economy, where, for example, it is judged that shocks to unemployment in one quarter will continue to have some effect on unemployment in successive quarters. The fan begins in 2017 Q4, a quarter earlier than the fan for CPI inflation. That is because Q4 is a staff projection for the unemployment rate, based in part on data for October and November. The unemployment rate was 4.3% in the three months to November, and is projected to be 4.3% in Q4 as a whole. A significant proportion of this distribution lies below Bank staff's current estimate of the long-term equilibrium unemployment rate. There is therefore uncertainty about the precise calibration of this fan chart.

Chart 5.3

CPI inflation projection based on market interest rate expectations, other policy measures as announced

Chart 5.3

Chart 5.4

CPI inflation projection in November based on market interest rate expectations, other policy measures as announced

Chart 5.4

  • Notes
    Charts 5.3 and 5.4 depict the probability of various outcomes for CPI inflation in the future. They have been conditioned on the assumptions in Table 5.B footnote (b). If economic circumstances identical to today's were to prevail on 100 occasions, the MPC's best collective judgement is that inflation in any particular quarter would lie within the darkest central band on only 30 of those occasions. The fan charts are constructed so that outturns of inflation are also expected to lie within each pair of the lighter red areas on 30 occasions. In any particular quarter of the forecast period, inflation is therefore expected to lie somewhere within the fans on 90 out of 100 occasions. And on the remaining 10 out of 100 occasions inflation can fall anywhere outside the red area of the fan chart. Over the forecast period, this has been depicted by the light grey background. See the box on pages 48–49 of the May 2002 Inflation Report for a fuller description of the fan chart and what it represents.

Chart 5.5

World GDP (PPP-weighted)(a)

Chart 5.5

  • Notes
    Sources: IMF World Economic Outlook and Bank calculations.

    (a) Annual average growth rates. Chained-volume measure. Constructed using real GDP growth rates of 181 countries weighted according to their shares in world GDP using the IMF's purchasing power parity (PPP) weights.

Table 5.C

MPC key judgements(a)(b)

Table 5.C

  • Notes
    Sources: Bank of America Merrill Lynch Global Research (used with permission), Bank of England, BDRC Continental SME Finance Monitor, Bloomberg, British Household Panel Survey, Department for Business, Energy and Industrial Strategy, Eurostat, IMF World Economic Outlook (WEO), ONS, US Bureau of Economic Analysis and Bank calculations.

    (a) The MPC's projections for GDP growth, CPI inflation and unemployment (as presented in the fan charts) are underpinned by four key judgements. The mapping from the key judgements to individual variables is not precise, but the profiles in the table should be viewed as broadly consistent with the MPC's key judgements.
    (b) Figures show annual average growth rates unless otherwise stated. Figures in parentheses show the corresponding projections in the November 2017 Inflation Report. Calculations for back data based on ONS data are shown using ONS series identifiers.
    (c) Chained-volume measure. Constructed using real GDP growth rates of 180 countries weighted according to their shares in UK exports.
    (d) Chained-volume measure. Constructed using real GDP growth rates of 181 countries weighted according to their shares in world GDP using the IMF's purchasing power parity (PPP) weights.
    (e) Chained-volume measure. Figure for 2017 is the outturn.
    (f) Chained-volume measure. Figure for 2017 is the outturn.
    (g) Chained-volume measure. Includes non-profit institutions serving households.
    (h) Chained-volume measure.
    (i) Chained-volume measure. Exports less imports.
    (j) Annual average. Chained-volume business investment as a percentage of GDP.
    (k) Level in Q4. Percentage point spread over reference rates. Based on a weighted average of household and corporate loan and deposit spreads over appropriate risk-free rates. Indexed to equal zero in 2007 Q3. Figure for 2017 is the Q4 outturn.
    (l) Based on the weighted average of spreads for households and large companies over 2003 and 2004 relative to the level in 2007 Q3. Data used to construct the SME spread are not available for that period. The period is chosen as broadly representative of one where spreads were neither unusually tight nor unusually loose.
    (m) Annual average. Percentage of total available household resources.
    (n) GDP per hour worked. GDP at market prices is based on the mode of the MPC's backcast.
    (o) Level in Q4. Percentage of the 16+ population.
    (p) Level in Q4. Average weekly hours worked, in main job and second job.
    (q) Four-quarter inflation rate in Q4.
    (r) Average level in Q4. Dollars per barrel. Projection based on monthly Brent futures prices. Figure for 2017 is the Q4 outturn.
    (s) Four-quarter growth in unit labour costs in Q4. Whole-economy total labour costs divided by GDP at market prices, based on the mode of the MPC's GDP backcast. Total labour costs comprise compensation of employees and the labour share multiplied by mixed income.

Table 5.D

Indicative projections consistent with the MPC's modal projections (a)

Table 5.D

  • Notes
    (a) These projections are produced by Bank staff for the MPC to be consistent with the MPC's modal projections for GDP growth, CPI inflation and unemployment. Figures in parentheses show the corresponding projections in the November 2017 Inflation Report. Calculations for back data are shown using ONS series identifiers.
    (b) Chained-volume measure. Includes non-profit institutions serving households.
    (c) Chained-volume measure.
    (d) Chained-volume measure. Whole-economy measure. Includes new dwellings, improvements and spending on services associated with the sale and purchase of property.
    (e) Chained-volume measure. The historical data exclude the impact of missing trader intra-community (MTIC) fraud.
    (f) Total available household resources deflated by the consumer expenditure deflator.
    (g) Whole-economy total pay.

Chart 5.6

Household saving rate (a)

Chart 5.6

  • Notes
    Sources: ONS and Bank calculations.

    (a) Annual average. Percentage of total available household resources.

Chart 5.7

Import price inflation (a)

Chart 5.7

  • Notes
    Sources: ONS and Bank calculations.

    (a) Projections are four-quarter inflation rate in Q4. Excludes the impact of MTIC fraud.

Table 5.F

Q4 CPI inflation

Table 5.F

  • Notes
    The table shows projections for Q4 four-quarter CPI inflation. The figures in parentheses show the corresponding projections in the November 2017 Inflation Report. The projections have been conditioned on the assumptions in Table 5.B footnote (b).

Chart 5.8

Projected probabilities of GDP growth in 2019 Q1 (central 90% of the distribution) (a)

Chart 5.8

  • Notes
    (a) Chart 5.8 represents the cross-section of the GDP growth fan chart in 2019 Q1 for the market interest rate projection. The grey outline represents the corresponding cross-section of the November 2017 Inflation Report fan chart for the market interest rate projection. The projections have been conditioned on the assumptions in Table 5.B footnote (b). The coloured bands in Chart 5.8 have a similar interpretation to those on the fan charts. Like the fan charts, they portray the central 90% of the probability distribution.
    (b) Average probability within each band; the figures on the y-axis indicate the probability of growth being within ±0.05 percentage points of any given growth rate, specified to one decimal place.

Table 5.G

Annual average GDP growth rates of modal, median and mean paths (a)

Table 5.G

  • Notes
    (a) The table shows the projections for annual average GDP growth rates of modal, median and mean projections for four-quarter growth of real GDP implied by the fan chart. Where growth rates depend in part on the MPC's backcast, revisions to quarterly growth are assumed to be independent of the revisions to previous quarters. The figures in parentheses show the corresponding projections in the November 2017 Inflation Report. The projections have been conditioned on the assumptions in Table 5.B footnote (b).

Chart 5.9

Inflation probabilities relative to the target

Chart 5.9

  • Notes
    The February and November swathes in this chart are derived from the same distributions as Charts 5.3 and 5.4 respectively. They indicate the assessed probability of inflation relative to the target in each quarter of the forecast period. The 5 percentage points width of the swathes reflects the fact that there is uncertainty about the precise probability in any given quarter, but they should not be interpreted as confidence intervals.

Chart 5.10

Projected probabilities of CPI inflation in 2020 Q1 (central 90% of the distribution) (a)

Chart 5.10

  • Notes
    (a) Chart 5.10 represents the cross-section of the CPI inflation fan chart in 2020 Q1 for the market interest rate projection. The grey outline represents the corresponding cross-section of the November 2017 Inflation Report fan chart for the market interest rate projection. The projections have been conditioned on the assumptions in Table 5.B footnote (b). The coloured bands in Chart 5.10 have a similar interpretation to those on the fan charts. Like the fan charts, they portray the central 90% of the probability distribution.
    (b) Average probability within each band; the figures on the y-axis indicate the probability of inflation being within ±0.05 percentage points of any given inflation rate, specified to one decimal place.

Chart 5.11

GDP projection based on constant nominal interest rates at 0.5%, other policy measures as announced

Chart 5.11

  • Notes
    See footnote to Chart 5.1.

Chart 5.12

CPI inflation projection based on constant nominal interest rates at 0.5%, other policy measures as announced

Chart 5.12

  • Notes
    See footnote to Chart 5.3.

Table 5.E
Monitoring risks to the Committee's key judgements

The Committee's projections are underpinned by four key judgements. Risks surround all of these, and the MPC will monitor a broad range of variables to assess the degree to which the risks are crystallising. The table below shows Bank staff's indicative near-term projections that are consistent with the judgements in the MPC's central view evolving as expected.

Key judgement

Likely developments in 2018 Q1 to 2018 Q3 if judgements evolve as expected

1: the broad-based strength in global growth continues

  • Quarterly euro-area GDP growth to average around ¾%.
  • Quarterly US GDP growth to average around ¾%.
  • Indicators of activity consistent with four-quarter PPP-weighted emerging market economy growth of around 5¼%; within that, GDP growth in China to average around 6¾%.

2: the rotation in UK GDP growth away from domestic consumption and towards external demand and investment continues

  • Quarterly growth in business investment to average ¾%.
  • Net trade to provide a significant boost to quarterly GDP growth.
  • Quarterly real post-tax household income growth to average ¼%.
  • Quarterly consumption growth to average ¼%.
  • Credit spreads to be broadly flat.
  • Mortgage approvals for house purchase to average around 65,000 per month.
  • The average of the Halifax/Markit and Nationwide house price indices to increase by just under ½% per quarter, on average.
  • Housing investment to be broadly flat.

3: very little slack remains and the pace of potential supply growth is modest

  • Unemployment rate to remain around 4¼%.
  • Participation rate to remain just above 63½%.
  • Average weekly hours worked to remain around 32.
  • Quarterly hourly labour productivity growth to average just over ¼%.

4: with demand outstripping potential supply, domestic inflationary pressures continue to build while the contribution from energy and import prices dissipates

  • Four-quarter growth in whole-economy AWE regular pay to rise to around 2¾%.
  • Four-quarter growth in whole-economy unit labour costs to average around 2¼%.
  • Non-fuel import prices to rise by ½% in the year to 2018 Q3.
  • Electricity and gas prices to be flat.
  • Commodity prices and sterling ERI to evolve in line with the conditioning assumptions set out in the February 2018 Inflation Report.
  • Indicators of medium-term inflation expectations to continue to be broadly consistent with the 2% target.

Box 6: Revisions to the MPC's productivity projections

Following the MPC's annual reassessment of supply-side conditions, potential supply growth over the forecast period is judged to be around 1½%, the same as in the November projections. Within that, the outlook for structural productivity growth is also broadly unchanged. But changes in the composition of spare capacity in the economy mean the MPC's projections for measured productivity — output per hour worked — have been revised down relative to November (Table 5.C). As explained in this box, that revision does not affect the outlook for trend growth over the forecast.

Structural labour productivity growth is a fundamental driver of potential supply growth in the economy and, hence, the pace of demand growth consistent with balanced inflationary pressures. It is determined by factors such as the availability of physical capital like buildings and IT equipment, and human capital like experience and education. Measured productivity — actual output per hour worked — can, however, temporarily deviate from its structural level for cyclical reasons. For example, if firms are underutilising their capital due to previous weakness in demand then there is scope for output to grow without an increase in the number of hours employees work. As demand recovers and firms use up that spare capacity, output per hour will grow even if structural productivity is unchanged. Output per hour worked could also rise above structural productivity if firms experience a temporary boost in demand for the goods and services they produce that leads them to operate above normal capacity levels, which would tend to lead to inflationary pressure.

In the November Report, growth in measured productivity — output per hour worked — was projected to rise to just over 1¼% over the forecast period (Table 5.C). Companies were judged to have some scope to increase their capital utilisation and around ¼ percentage point of the projected rise in productivity growth reflected companies using up that spare capacity. The rest of the pickup in productivity growth reflected a rise in structural productivity.

In this Report, the MPC has reassessed its view of the composition of slack remaining in the economy. With almost no spare capacity judged to be remaining in companies' capital utilisation, output per hour worked is projected to grow broadly in line with structural productivity. As explained in Key Judgement 3, the outlook for structural productivity growth is broadly unchanged from the November projections and embodies a rise to just over 1% over the forecast period (Table 5.C).

Box 7: Other forecasters' expectations

This box reports the results of the Bank's most recent survey of external forecasters, carried out in January.1 On average, respondents expected four-quarter GDP growth to slow a little further over the coming year, before picking up to 1¾% in three years' time (Table 1). Relative to expectations three months ago, that average GDP growth forecast was broadly unchanged at the one and two-year horizons but weaker further ahead (Chart A). External forecasters, on average, continued to expect a small rise in unemployment, but to a lower level than three months ago.

External forecasters' central expectations for CPI inflation at the one and two-year horizons were, on average, lower than three months ago. On average, external forecasters placed around a 50% probability on inflation being at or above the 2% target in two years' time, lower than the 60% average probability placed on that outcome three months ago (Chart B).

External forecasters, on average, expected somewhat less monetary stimulus over the next three years than they did at the time of the November Report, broadly consistent with the steepening of the market-implied path for Bank Rate (Chart C). As in November, almost all forecasters expected the current stock of gilt and corporate bond purchases to remain unchanged over the next three years.

Table 1

Averages of other forecasters' central projections(a)

Table 1

  • Notes
    Sources: Projections of outside forecasters as of 29 January 2018.

    (a) For 2019 Q1, there were 23 forecasts for CPI inflation, 23 for GDP growth, 19 for the unemployment rate, 21 for Bank Rate, 15 for the stock of gilt purchases, 12 for the stock of corporate bond purchases and 13 for the sterling ERI. For 2020 Q1, there were 18 forecasts for CPI inflation, 17 for GDP growth, 15 for the unemployment rate, 19 for Bank Rate, 14 for the stock of gilt purchases, 11 for the stock of corporate bond purchases and 10 for the sterling ERI. For 2021 Q1, there were 16 forecasts for CPI inflation, 16 for GDP growth, 13 for the unemployment rate, 17 for Bank Rate, 13 for the stock of gilt purchases, 10 for the stock of corporate bond purchases and 10 for the sterling ERI.
    (b) Twelve-month rate.
    (c) Four-quarter percentage change.
    (d) Original purchase value. Purchased via the creation of central bank reserves.

Chart A

Expectations of GDP growth three years ahead have declined
Average of forecasters' central projections for four-quarter GDP growth

Chart A

  • Notes
    Sources: Projections of outside forecasters provided for Inflation Reports between February 2008 and February 2018.

Chart B

Risks to inflation are now judged to be broadly balanced around 2%
Average of forecasters' probability distributions for CPI inflation in two years' time (a)

Chart B

  • Notes
    Sources: Projections of outside forecasters provided for Inflation Reports in November 2017 and February 2018.

    (a) Projections on the boundary of these ranges are included in the upper range, for example a projection of inflation being 2.0% is in the 2.0% to 2.5% range.

Chart C

Expectations of Bank Rate are slightly higher than in November
Market interest rates and average of forecasters' central projections for Bank Rate

Chart C

  • Notes
    Sources: Bloomberg, projections of outside forecasters provided for Inflation Reports in November 2017 and February 2018 and Bank calculations.

    (a) Estimated using instantaneous forward overnight index swap rates in the 15 working days to 25 October 2017 and 31 January 2018.
This page was last updated 25 July 2018
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