Visual summary - Inflation Report May 2018

The outlook for the economy

In a nutshell

The fall in the pound has led to higher prices

The fall in the pound has led to higher prices

The world economy is  growing robustly

The world economy is growing robustly

The squeeze in living standards is easing

The squeeze in living standards is easing

Inflation is falling back towards our 2% target

Inflation is falling back towards our 2% target

We cut 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 have been changing. The world economy is now growing relatively robustly. 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. And although it has fallen in recent months, is still above our 2% target.

Growth dipped earlier this year. We think at least part of that was due to the effects of the snow and so will be short-lived. The snow made it harder for people to get to work and reduced spending on things like going out for a meal. And it would have made it harder to do some work like building houses. If it was just snow, growth should pick up again. But we won’t know for sure until we see more evidence.

Last November, we raised the official interest rate we set, known as Bank Rate, from 0.25% to 0.5%. If the economy continues to perform as expected, it will probably be growing about as fast as it can without overheating. In that case we think we would need to raise interest rates further, reducing the amount of support we are providing to the economy.

Higher interest rates might seem a bad thing, especially if you have a lot of debt. But they are a sign of an economy growing about as fast as it can and that is able to support higher wages. Small increases in interest rates now can avoid the need for bigger ones later.

Bad weather affected growth

Part of the dip in growth earlier this year was probably due to the bad weather

Why is inflation above our target?

The reason we focus on low and stable inflation is that it is vital for a stable economy that supports growth and jobs. Our role is to set interest rates to influence the amount of spending in the economy in order to ensure inflation returns to our 2% target sustainably.

But inflation can also be pushed around by other factors outside of our control. Inflation is currently above the 2% 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 have been passing those rising costs on to their customers. So that has meant higher prices in the shops.

A lot of the increase in prices due to the fall in the pound has now happened, so inflation has started to fall back towards our target. It was around 3% at the end of last year but fell back to 2.5% in March. And we expect it to fall back further.

A pound coin falling

The pound has fallen since the Brexit vote

  • Expand chart See how we expect inflation to continue to fall back towards our target
    Chart: we expect inflation to continue to fall back towards our target

Back to top

How are we getting inflation back to target?

To make sure inflation falls back all the way to our 2% target and stays there, 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.

During the financial crisis, people reined in their spending and many lost their jobs. We had to cut interest rates to exceptionally low levels to support spending and jobs. 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 have been changing.

Inflation target 2%

We set interest rates to get inflation back to our 2% target

Back to top

A robust world economy

Just like at home, the world economy was quite weak following the financial crisis. But over the past two years, global growth has accelerated.

Growth dipped a bit earlier this year in the US and some European countries. Like here, that probably reflected temporary factors and so should recover.

Strong growth abroad is benefiting the UK by increasing demand for our . And it should encourage companies to invest to meet this extra demand.

Stronger growth in the world economy will benefit the UK

Robust growth in the world economy will benefit the UK

Back to top

The squeeze on pay is easing

Over 2017, prices were rising faster than wages meaning people were not able to afford as much. That is now starting to change.

Pay rises for most have been pretty low. But recently wages on average have started to rise faster than prices again. That is easing the squeeze on people's living standards.

That squeeze should ease further this year, supporting growth in the economy. The share of people out of work is now at its lowest level for more than 40 years. And there are a lot of job vacancies. This means that companies need to compete hard with each other to recruit and retain workers. One way they do that is by offering higher pay. The pressure in the jobs market means we're expecting to see bigger, more widespread pay rises in coming years.

We think that pay will rise faster than prices this year

We think that pay will rise faster than prices this year

  • Expand chart See how pay is starting to rise more than prices
    Chart: pay is starting to rise more than prices

Back to top

How fast can the economy grow?

We think our economy is probably growing about as fast as it can without overheating. That means for inflation to settle back at the 2% target, the economy probably needs to grow at around 1½% in coming years.

The speed limit for growth 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 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 might sound dull but for an economy it's a big deal. Improvements in everyone's standard of living depend on their ability to produce more with the resources they have.

A big driver of productivity is investment in new tools and technology. We can use them to complete tasks more quickly or more cheaply, freeing up our time or money to spend on other things. And perhaps create new things that we couldn't before.

There has been a lack of investment and productivity over the past decade. Productivity has barely risen over that time. It's hard to be sure, but we think that productivity will probably continue to grow relatively slowly in coming years, too.

Growth machine

Growth is determined by how many people are in work and how productive they are

There is a limit to how fast the economy can grow before it leads to higher inflation

  • Expand chart See how productivity has hardly grown since the financial crisis
    Chart: productivity has hardly grown since the financial crisis

Back to top

The interest rate decision

Inflation has started to fall back towards our 2% target, having been pushed up by the sharp fall in the pound triggered by the EU referendum.  To ensure a sustainable return of inflation to the target, we need to keep the economy growing at around its speed limit.

After raising interest rates last November from 0.25% to 0.5%, this month we have left them unchanged. If the economy performs broadly as we expect, then we will need to reduce the amount of support we are providing to make sure inflation returns sustainably to the target. We think that will probably require further modest rises in interest rates over the next few years.  We expect any 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.

This page was last updated 10 May 2018
Was this page useful?
Add your details...