Visual summary - Inflation Report February 2018

The outlook for the economy

In a nutshell

The economy now needs a little less support

We cut interest rates to exceptionally low levels during the financial crisis to support spending and to reduce the number of people out of work.

Over the past few years our economy has needed interest rates to stay very low as we recovered from the global financial crisis.

But things are changing. The world economy is now growing strongly. In the UK, the share of people without a job is at its lowest level for over 40 years, and businesses are finding it hard to recruit people. Our economy is probably growing about as fast as it can without overheating. And inflation is above our 2% target.

That means the economy needs a little less support than before. So last November, we raised the official interest rate we set, known as Bank Rate, from 0.25% to 0.5%. In February, we have kept it at 0.5%.

The economy is strong enough for us to remove some support

Inflation and the fall in the pound

Our job is to meet the 2% inflation target. Inflation is currently above that target, because of the big fall in the pound following the Brexit vote.

The lower pound has meant that things businesses get from abroad cost more. Businesses will need to pass those rising costs on to their customers. So that has meant higher prices in the shops.

The fall in the pound happened around 18 months ago. Its effect on inflation doesn't last forever. And in the next few months inflation is going to start to fall back gradually towards our target.

The pound has fallen since the Brexit vote
  • Chart See how the pound has fallen since the Brexit vote
    The pound has fallen since the Brexit vote

A strong world economy

Just like at home, the world economy had been quite weak following the financial crisis. But across Europe, in the US and many other countries the economy is now growing strongly.

Stronger growth abroad will benefit the UK by increasing demand for our exports. And it should encourage companies to invest and recruit more staff to meet this extra demand.

Stronger growth in the world economy will benefit the UK

The squeeze on pay is easing

Over the past year, prices have been rising faster than wages. That means people have not been able to afford as much. We think that is changing.

The share of people out of work is now at its lowest level since 1975. And there are a lot of job vacancies. This means that companies are having to compete hard with each other to recruit and retain workers. One way they do that is by offering higher wages – so we expect bigger pay rises over the next few years.

We think that pay will rise faster than prices this year, easing the squeeze on living standards.

We think that pay will rise faster than prices this year
  • Chart See how we expect pay to start to rise more than prices
    We expect wages to start to rise more than prices

Getting inflation back to target

To make sure inflation falls back to our 2% target, we need to set interest rates so that the amount of spending in the economy isn't too low or too high. If we set interest rates too low, then growth in the economy will be too fast, and inflation will stay above our target. But if we set interest rates too high or raise them too rapidly then growth will be too slow, and inflation will fall below our target.
Put another way, we need to keep the economy growing at its speed limit.

We set interest rates to get inflation back to our 2% target
  • Chart See how we expect inflation to fall back towards our target
    We expect inflation to fall back towards our target

The speed limit for the economy is determined by two things: how many people are in work; and how productive the businesses they work for are.

A few years ago many more people were out of work. So there was scope for the economy to grow quite quickly as a lot of those people found jobs.

Now, with a record number of people in work, there isn't much more economic growth that can come from unemployed people finding work. Instead, it will mostly need to come from higher productivity - our ability to produce more with the people already in work and the resources that we have.

But productivity has barely risen over the past decade. And we think that productivity will probably grow relatively slowly in coming years, too.

We think that for inflation to settle back at the 2% target, the economy probably needs to grow at around 1½% in coming years.

The economy can only grow so fast before it leads to higher inflation

  • Chart See how productivity has hardly grown since the financial crisis
    Productivity has hardly grown since the financial crisis
Governor Mark Carney

"With the world economy strengthening and UK growth just above our economy's speed limit, we expect to reduce some of the support we are providing to the economy in order to bring inflation back to its 2% target. But interest rates are likely to remain substantially lower than a decade ago."

Mark Carney, Governor of the Bank of England

The interest rate decision

Inflation has been above our 2% target over the past year because of the sharp fall in the pound triggered by the EU referendum. During that time, we had to balance how quickly we take inflation back to the target with the support we give to jobs and activity. To ensure a sustainable return of inflation to the target, we need to keep economic growth around its new, lower, speed limit.

With a strengthening world economy and more people in work, the UK economy now needs a little less support from us. We raised interest rates in November from 0.25% to 0.5%. If the economy continues to perform as expected, we think we will need to raise them further, reducing the amount of support we are providing to the economy.  We expect any further rises in interest rates to happen at a gradual pace and to a limited extent.  Interest rates are likely to remain substantially lower than a decade ago.

Was this page useful?
Add your details...