Prospects for inflation

Section 5 of the Inflation Report - August 2019

Underlying UK GDP growth has softened to below-potential rates, reflecting weaker global growth as well as the impact of Brexit-related uncertainties. Growth is expected to remain subdued in coming quarters, as those uncertainties have intensified over the past few months and are assumed to remain elevated in the near term. CPI inflation is projected to fall temporarily below the MPC’s 2% target over the second half of 2019 as energy prices decline. Conditioned on a smooth withdrawal of the UK from the EU, Brexit-related uncertainties are assumed to subside over the forecast period. Together with a boost from looser monetary conditions, the decline in uncertainties leads to a recovery in demand growth to robust rates. As a result, excess demand and domestic inflationary pressures build. CPI inflation picks up to materially above the MPC’s 2% target by the end of the forecast period.

The MPC’s projections are affected by an inconsistency between the asset prices on which they are conditioned — which reflect a higher perceived probability of a no-deal Brexit among financial market participants — and the smooth Brexit assumption underlying the central forecasts. In the event of a Brexit deal, sterling would be likely to appreciate and market interest rates and UK-focused equity prices to rise. Box 6 shows some stylised sensitivities of the MPC’s projections to changes in asset prices.

UK GDP growth has been more volatile than usual over the first half of 2019, largely due to developments relating to Brexit. For example, GDP growth of 0.5% in 2019 Q1 was boosted by companies building up stocks in order to mitigate the effects of a possible disruptive EU exit on 29 March. For the same reason, some firms in the car industry brought forward their usual summer shutdowns to April, and the resulting decline in production weighed on output in Q2. The unwind of the effect from stockbuilding will also have weighed on GDP growth in that quarter. UK GDP is expected to have been flat in Q2.

Abstracting from those temporary factors, the underlying pace of UK GDP growth appears to have slowed since 2018 to below its potential rate. Subdued underlying UK GDP growth reflects weaker global growth as well as the impact of Brexit related uncertainties. Those factors are expected to continue to weigh on growth in the near term, and to a greater extent than was expected at the time of the May Report. Globally, growth has slowed and is expected to remain at below-potential rates over coming quarters, partly reflecting the impact of an intensification of trade tensions. Domestically, firms’ perceived uncertainties related to the Brexit process have become more entrenched. Contacts of the Bank’s Agents report having become more uncertain about the economic outlook than they had been prior to the extension of the EU withdrawal deadline (Box 2). The proportion of respondents to the DMP Survey that expect uncertainty to be resolved in the near term has fallen significantly over the past few months (Section 2). Those uncertainties about the nature of the transition and the UK’s eventual trading relationship with the EU, and therefore the economy’s future path, will weigh on spending.

Underlying UK GDP growth is projected to remain relatively soft over the next few quarters, and is somewhat weaker than in May. As a result, the small margin of excess supply that is judged to have emerged persists over the next year or so. Headline output growth may continue to be volatile around that underlying path while Brexit-related uncertainties remain elevated.

CPI inflation has been close to the MPC’s target throughout 2019 so far and was 2.0% in June. Inflation is expected to fall in the near term, reflecting lower energy prices. Core inflation, which excludes the effects of energy, food, alcohol and tobacco, was 1.8% in June, and is expected to be close to that rate over much of 2019 H2.

As in previous Reports, and consistent with the general approach to condition forecasts on Government policy, the MPC’s projections (summarised in Table 5.A) assume a smooth transition to the average of a range of possible outcomes for the United Kingdom’s eventual trading relationship with the European Union.1 Consistent with that conditioning assumption, Brexit uncertainties are assumed to wane over the second half of the forecast period. All else equal, this boosts GDP growth and inflation.

The projections are also conditioned on a range of UK asset prices. Over the past few months, monetary conditions have loosened. The market yield curve currently implies that Bank Rate is expected to fall in the near term, and ends the forecast period at 0.6% (Table 5.B), around 40 basis points lower than in the May 2019 Report. The sterling exchange rate is 4% lower than in May. The lower path for market interest rates partly reflects the influence of global factors; interest rate expectations have fallen in the US and euro area as well as the UK (Section 1). UK asset price developments have also been driven by the growing weight that market participants have placed on the possibility of a no-deal Brexit. In contrast to the MPC’s forecast, which assumes a smooth Brexit, asset prices encompass the full range of potential Brexit outcomes, and the rising perceived likelihood of no deal has contributed to the lower market path for interest rates and the depreciation of the exchange rate, as well as weighing on some risky asset prices. Taken together, financial and monetary conditions have become more supportive of GDP growth and CPI inflation.

Under these assumptions, GDP growth is projected to pick up during 2020 and to be robust throughout the rest of the forecast period (Chart 5.1). Global growth picks up gradually, supported by lower interest rates in advanced economies (Key Judgement 1). UK domestic demand growth also rises as the dampening effect from Brexit-related uncertainties dissipates (Key Judgement 2). UK GDP growth is higher than in May in the latter part of the forecast period (Table 5.C), reflecting the boost to demand from looser monetary conditions.

As in previous Reports, potential supply growth is expected to remain subdued relative to pre-crisis rates. Consequently, the pickup in GDP growth to robust rates results in rising excess demand, which reaches 1¾% of potential GDP by the end of the forecast period, materially higher than in May (Key Judgement 3). The unemployment rate is projected to fall to 3.3% (Chart 5.2), well below the MPC’s estimate of its equilibrium rate of 4¼%.

Building excess demand leads to rising domestic inflationary pressures. After falling in the near term, CPI inflation is projected to rise above the MPC’s 2% target (Chart 5.3). At the end of the forecast period, it is 2.4%, notably higher than in the May Report (Chart 5.4).

However, while these projections assume that there is a smooth Brexit, the asset prices on which they are conditioned have been affected by a higher perceived probability of a no-deal Brexit. In the event of a Brexit deal, sterling would be likely to appreciate and market interest rates and UK-focused equity prices to rise. To illustrate the impact of those effects, Box 6 shows stylised sensitivities of the MPC’s projections to changes in asset prices. Illustrations suggest that projections for excess demand and inflation would be lower based on asset price assumptions more consistent with a smooth Brexit.

At its meeting ending on 31 July 2019, the MPC voted to maintain Bank Rate at 0.75%, 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.2 The remainder of this section sets out the MPC’s projections and the risks around them in more detail.

Table 5.A

Forecast summaryab

Table 5.A

  • a Modal projections for GDP, CPI inflation, LFS unemployment and excess supply/excess demand. Figures in parentheses show the corresponding projections in the May 2019 Inflation Report. Projections were only available to 2022 Q2 in May.
    b The projections have been conditioned on the Term Funding Scheme and the prevailing prices of a broad range of assets, which embody market expectations of the future stocks of purchased gilts and corporate bonds. The main assumptions are set out in the ‘Download the chart slides and data’ link at
    www.bankofengland.co.uk/inflation-report/2019/august-2019.
    c Four-quarter growth in real GDP. The growth rates reported in the table exclude the backcast for GDP. Including the backcast 2019 Q3 growth is 1.0%, 2020 Q3 growth is 1.4%, 2021 Q3 growth is 2.4% and 2022 Q3 growth is 2.5%. This compares to 1.3% in 2019 Q3, 1.7% in 2020 Q3 and 2.1% in 2021 Q3 in the May 2019 Inflation Report.
    d Four-quarter inflation rate.
    e Per cent of potential GDP. A negative figure implies output is below potential and a positive figure that it is above.
    f Per cent. The path for Bank Rate implied by forward market interest rates. The curves are based on overnight index swap rates.

Table 5.B

Conditioning path for Bank Rate implied by forward market interest ratesa

Table 5.B

  • a The data are 15 working day averages of one day forward rates to 24 July 2019 and 24 April 2019 respectively. The curve is based on overnight index swap rates.
    b August figure for 2019 Q3 is an average of realised overnight rates to 24 July 2019, and forward rates thereafter.

Chart 5.1

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

Chart 5.1

  • The fan chart depicts the probability of various outcomes for GDP growth. It has been conditioned on the assumptions in Table 5.A footnote b. To the left of the vertical dashed line, the distribution reflects uncertainty around revisions to the data over the past. To aid comparability with the official data, it does not include the backcast for expected revisions, which is available from the ‘Download the chart slides and data’ link at www.bankofengland.co.uk/inflation-report/2019/august-2019. To the right of the vertical line, the distribution 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.

Table 5.C

Annual average GDP growth rates of modal, median and mean pathsa

Table 5.C

  • 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. The figures in parentheses show the corresponding projections in the May 2019 Inflation Report excluding the backcast. The projections have been conditioned on the assumptions in Table 5.A footnote b.

Chart 5.2

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

Chart 5.2

  • The fan chart depicts the probability of various outcomes for LFS unemployment. It has been conditioned on the assumptions in Table 5.A 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 2019 Q2, a quarter earlier than the fan for CPI inflation. That is because Q2 is a staff projection for the unemployment rate, based in part on data for April and May. The unemployment rate was 3.8% in the three months to May, and is projected to be 3.8% in Q2 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 May based on market interest rate expectations, other policy measures as announced

Chart 5.4

  • 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.A 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.

5.1 The MPC’s key judgements and risks

Key Judgement 1: while global activity has weakened and sentiment has deteriorated, looser financial conditions support the return of world growth to its potential rate in the medium term

Since late 2017, there has been a material and broad-based slowdown in world growth. Four-quarter global GDP growth — based on PPP weights — has slowed from above-potential rates of close to 4% to around 3% at the beginning of 2019. Higher-frequency indicators suggest that global growth is likely to remain subdued in the near term. For example, the JPMorgan global manufacturing export orders PMI has remained at low levels over the past few months (Section 1). In the near term, four-quarter global growth is expected to be somewhat weaker than in May.

The softening in the growth outlook appears in part to have reflected the impact of trade tensions, which have intensified since the May Report. Trade tensions are likely to affect the global economy through both direct and indirect channels. The estimated direct trade effects of the tariffs announced to date are relatively small, lowering PPP-weighted world GDP by around 0.2% by the end of the forecast period. These effects may be magnified by indirect effects of trade policy uncertainty on business confidence, which has deteriorated over the past year or so, particularly in the manufacturing sector. The indirect effects are judged likely to have dampened growth recently and continue to weigh a little on activity over the forecast period.

The slowdown has also reflected the impact of the tightening in financial conditions that occurred during 2018. That tightening was driven in part by the withdrawal of monetary stimulus by the US Federal Reserve, which affected financial conditions in emerging economies too. Growth in China also weakened in response to past domestic policy tightening.

Over 2019 so far, global financial conditions have eased. In particular, forward interest rates have fallen substantially in advanced economies. Easier monetary conditions in the US are expected to continue to contribute to looser financial conditions in emerging markets. Policy measures are also expected to support growth in China. Market participants’ expectations of interest rates in advanced economies appear to have eased partly in response to the slowdown in global activity and subdued inflationary pressures. Inflation has remained weak in the euro area and is also a little below target in the US.

In the central forecast, the easing in global financial conditions supports a gradual pickup in world GDP growth to its potential rate by the end of the forecast period. PPP-weighted global growth is projected to rise from 3% in 2019 to 3¼% in 2020 and 3½% in 2021 (Chart 5.5). Weighted by UK export shares, growth is expected to pick up from 2% in 2019 to 2¼% by 2021 (Table 5.E). Those projections are a little lower than three months ago, partly reflecting a greater drag from trade tensions.

The MPC judges that the risks around those projections are broadly balanced. On the one hand, the indirect effects of uncertainty on confidence might be smaller than judged likely in the central projection. On the other, trade tensions could intensify further.

Lower global growth will weigh on UK exports growth relative to May. In addition, net trade has been weaker than expected over the past, and some of that weakness is judged likely to persist over the forecast period, partially offsetting the boost to net trade from sterling’s recent depreciation. The contribution of net trade to annual GDP growth is expected to be volatile over 2019 and 2020, reflecting the impact of Brexit-related stockbuilding of imported goods in the UK. In 2021, net trade makes a broadly neutral contribution to UK GDP growth (Table 5.E).

Global factors have weighed on market interest rate expectations in the UK, which have also been affected by the perceived increase in the probability of a no-deal Brexit. The lower expected path for interest rates boosts UK domestic demand relative to the May forecast.

Key Judgement 2: on the conditioning assumption that there is a smooth Brexit, UK demand growth recovers after softening in the near term

As expected, recent UK output data have been volatile, in large part owing to Brexit-related effects on businesses. After growing by 0.5% in 2019 Q1, GDP is expected to have been flat in Q2 (Section 2).

Looking through recent volatility, underlying UK GDP growth appears to have softened in the first half of 2019 to below potential rates. Subdued growth partly reflects the impact of weaker global demand (Key Judgement 1), as well as the impact of Brexit uncertainties.

Over the past few months, firms’ reported uncertainties about Brexit — and therefore about the economy’s future path — have picked up. Contacts of the Bank’s Agents report being more uncertain about the economic outlook and the proportion of respondents to the DMP Survey who expect uncertainty to be resolved by the end of 2019 is down from around 40% three months ago to less than 20%. The MPC judges that underlying UK GDP growth is likely to remain subdued over the coming year, with Brexit-related uncertainties weighing on spending to a greater extent than in May.

Elevated Brexit uncertainties have weighed heavily on investment spending. Although business investment is estimated to have grown a little in 2019 Q1, that figure may have been affected by the introduction of a new accounting standard, IFRS 16 (Section 2). More broadly, investment remains low relative to previous expansions and to other countries. Surveys of investment intentions suggest that business spending is likely to remain weak over coming quarters.

Compared with business investment, household consumption growth has remained relatively strong during 2019 H1, underpinned by continued solid growth in real incomes. Consumption growth is projected to be steady in the near term and to remain resilient relative to growth in business investment.

The MPC’s forecast is conditioned on an assumption that there is a smooth Brexit. Consistent with that assumption, Brexit related uncertainties continue to be elevated over the first year of the forecast before subsiding over the second and third years. GDP growth is subdued initially before picking up strongly in the latter part of the forecast period. In particular, as details of the UK’s future trading relationships gradually emerge, business investment recovers (Chart 5.6).

Accommodative monetary conditions also boost domestic demand, supporting business investment and contributing to a recovery in housing investment. Household consumption growth also picks up over the forecast period (Table 5.F), as does real income growth, reflecting further falls in unemployment and relatively strong wage growth (Key Judgement 3).

The easing in monetary conditions means that the MPC’s projection for GDP growth over the latter part of the forecast period is higher than in May. Four-quarter UK demand growth rises to 2.5% in 2022. The risks around the MPC’s forecast, which is conditioned on a smooth Brexit, are judged to be broadly balanced. The outlook for demand will depend significantly on the outcome of the UK’s withdrawal from the EU, and how households, companies and financial markets respond to developments in the Brexit process.

Key Judgement 3: as GDP growth recovers to above the subdued rate of potential supply growth, excess demand and domestic inflationary pressures build

In the run-up to the February Report, the MPC completed its regular assessment of UK supply conditions, and judged that potential supply would continue to grow at a subdued pace, much lower than before the financial crisis. Much of the weakness relative to pre-crisis norms reflects a judgement that potential productivity will grow more slowly. Potential productivity growth is also likely to be affected by the prolonged period of uncertainty and weaker investment associated with the Brexit process.

Over 2019, underlying GDP growth is judged likely to be below its potential rate, such that a small margin of excess supply in the economy emerges. Further out, however, as demand growth picks up to above potential supply growth, excess demand builds. Given the robust pace of GDP growth (Key Judgement 2), excess demand reaches 1¾% of potential GDP by the end of the forecast period. The unemployment rate falls to 3.3%.

As excess demand builds, domestic inflationary pressures rise. The further declines in unemployment put upward pressure on wage growth, which has risen over the past couple of years (Section 3). Growth in unit labour costs has been robust over the recent past, given relatively strong wage growth and weak productivity growth (Section 4). Given the projected rise in wage growth, unit labour costs grow robustly in the latter part of the forecast period even as productivity growth recovers somewhat. In contrast to labour cost growth, some price based measures of domestically generated inflation have remained relatively low by historical standards over the past couple of years. As a result, companies’ margins in the consumer sector may currently be squeezed. Over the forecast period, consumer-facing companies’ margins are assumed to recover and build further as excess demand grows, adding to inflationary pressures.

Domestically generated inflation is projected to exert upward pressure on CPI inflation over the next three years, such that CPI inflation ends the forecast materially above the MPC’s 2% target. In the near term, however, inflation is projected to fall, largely due to lower energy prices, which are expected to decline in 2019 H2. Given the MPC’s conditioning assumptions about the wholesale costs of oil, gas and electricity, energy prices are projected to make a broadly neutral contribution to inflation over the second half of the forecast period (Box 5). That is a little higher than in May, at which point the forecast was conditioned on a downward-sloping oil futures curve, rather than an assumption that oil prices would remain flat. The 4% depreciation of sterling over the past three months also puts some upward pressure on CPI inflation relative to the May Report.

Conditional on market interest rates and other asset prices, as well as a smooth Brexit, CPI inflation is projected to be 2.4% in 2022 Q3 and is still rising at the end of the forecast period (Chart 5.7). The projection is notably higher than in May, largely reflecting the greater degree of excess demand. Relative to the MPC’s central case, the risks to inflation are judged to be broadly balanced.

As with GDP growth, the MPC’s projection for inflation will depend significantly on Brexit developments.

Chart 5.4

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

Chart 5.4

  • 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.A 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

  • Sources: IMF WEO 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.E

MPC key judgementsab

Table 5.E

  • Sources: Bank of England, BDRC Continental SME Finance Monitor, Bloomberg Finance L.P., British Household Panel Survey, Department for Business, Energy and Industrial Strategy, Eurostat, ICE/BoAML Global Research (used with permission), 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 three 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 May 2019 Inflation Report.
    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. Forecast was finalised before the release of the preliminary flash estimate of euro-area GDP for Q2, so that has not been incorporated.
    f Chained-volume measure. Forecast was finalised before the release of the advance estimate of US GDP for Q2, so that has not been incorporated.
    g Chained-volume measure. Exports less imports.
    h Chained-volume measure.
    i Chained-volume business investment as a percentage of GDP.
    j Chained-volume measure. Includes non-profit institutions serving households.
    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.
    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.
    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 excluding fuel and the impact of MTIC fraud.
    r Average level in Q4. Dollars per barrel. Projection based on monthly Brent futures prices for the first two quarters of the forecast period, then held flat.
    s Four-quarter growth in unit labour costs in Q4. Whole-economy total labour costs divided by GDP at constant 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.
    t Four-quarter growth in whole-economy unit wage costs in Q4. Whole-economy wage costs divided by GDP at constant prices, based on the mode of the MPC’s GDP backcast. Total wage costs are wages and salaries excluding non-wage costs and the labour share multiplied by mixed income.
    u Four-quarter growth in private sector regular pay based unit wage costs in Q4. Private sector wage costs divided by private sector output at constant prices, based on the mode of the MPC’s GDP backcast. Private sector wage costs are average weekly earnings (excluding bonuses) multiplied by private sector employment.

Chart 5.6

Business investmenta

Chart 5.6

  • Sources: ONS and Bank calculations.

    a Annual average growth rates. Chained-volume measure. Business investment data based on GAN8. Investment data take account of the transfer of nuclear reactors from the public corporation sector to central government in 2005 Q2.

Table 5.F

Indicative projections consistent with the MPC’s modal projectionsa

Table 5.F

  • 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 May 2019 Inflation Report.
    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 Wages and salaries plus mixed income and general government benefits less income taxes and employees’ National Insurance contributions, deflated by the consumer expenditure deflator.
    g Whole-economy total pay.

Chart 5.7

Inflation probabilities relative to the target

Chart 5.7

  • The August and May 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.

5.2 The projections for demand, unemployment and inflation

Based on the judgements above and conditioned on the market path for Bank Rate, as well as an assumption of a smooth withdrawal from the EU, the MPC projects four quarter GDP growth to be below potential in the near term, before picking up to around 2½%. The pickup in demand growth is mainly driven by business investment growth, as Brexit uncertainties are assumed to subside. The risks around the projection, which is conditioned on a smooth Brexit, are broadly balanced.

The economy’s supply capacity is judged likely to grow at a subdued pace — of around 1½% per year on average — over the forecast period. In the near term, there is a small margin of excess supply, but as growth recovers, excess demand builds and the unemployment rate falls.

CPI inflation is projected to fall temporarily below the MPC’s 2% target in the second half of 2019, largely reflecting a decline in energy prices. CPI inflation is then judged likely to rise above the target supported by domestic inflationary pressures (Table 5.G). The risks around the inflation projection remain balanced.

Charts 5.8, 5.9 and 5.10 show the MPC’s projections under the alternative constant rate assumption. That assumption is that Bank Rate remains at 0.75% throughout the three years of the forecast period, before moving towards the market path over the subsequent three years. Under that path, GDP growth is a little weaker for most of the forecast period and unemployment is a little higher. Inflation is slightly lower, although it still ends the forecast above the target.

  • 1. Unless otherwise stated, the projections shown in this section are conditioned on: Bank Rate following a path implied by market yields; the Term Funding Scheme; 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 Spring Statement 2019; commodity prices following market paths for two quarters, then held flat; the sterling exchange rate remaining broadly flat; and the prevailing prices of a broad range of other assets. The asset prices that the forecast is conditioned on embody market expectations of the future stocks of purchased gilts and corporate bonds. The main assumptions are set out in the ‘Download the chart slides and data’ link of the August 2019 Inflation Report.

    2. The Minutes are available here.

Table 5.G

Q4 CPI inflation

Table 5.G

  • The table shows projections for Q4 four quarter CPI inflation. The figures in parentheses show the corresponding projections in the May 2019 Inflation Report. The projections have been conditioned on the assumptions in Table 5.A footnote b.

Chart 5.8

GDP projection based on constant nominal interest rates at 0.75%, other policy measures as announced

Chart 5.8

  • See footnote to Chart 5.1.

Chart 5.9

CPI inflation projection based on constant nominal interest rates at 0.75%, other policy measures as announced

Chart 5.9

  • See footnote to Chart 5.3.

Chart 5.10

Unemployment rate projection based on constant nominal interest rates at 0.75%, other policy measures as announced

Chart 5.10

  • See footnote to Chart 5.2.

Box 6: The sensitivities of the MPC’s projections to financial market expectations about the Brexit outcome

Consistent with the general approach to condition forecasts on Government policy, the MPC’s projections assume a smooth transition to the average of a range of possible outcomes for the UK’s eventual trading relationship with the EU. The MPC’s projections do not include the possibility that the UK leaves the EU without a deal.

The MPC also conditions its projections on a range of UK asset prices, including market interest rate expectations, the sterling exchange rate, equity prices, corporate bond spreads and bank funding spreads. In contrast to the MPC’s Brexit assumption, actual asset prices do take into account the full range of possible Brexit outcomes — including a no-deal Brexit. Asset prices will be affected by the probability market participants attach to each of those outcomes, as well as their judgements about the likely responses of asset prices in each of those events.

Given the MPC’s conditioning assumptions, there are some inconsistencies in the forecast. This box is intended to provide some stylised illustrations of the scale of those effects.

Betting odds (Chart A) and the Reuters survey of economists suggest that the perceived probability of a no-deal Brexit has risen markedly since May. As a result, sterling’s exchange rate (Chart A) and UK-focused equity prices (Chart 1.6) have fallen. In addition, because many financial market participants expect a monetary loosening in a no-deal Brexit, they have marked down their expectations for Bank Rate (Chart 1.5).

The rising perceived likelihood of no deal and market participants’ judgements about the effects on the economy and on monetary policy in that event will therefore have moved asset prices further away from levels consistent with the MPC’s assumption of a smooth Brexit.

If Brexit proceeds smoothly to some form of deal, asset prices would adjust: the market path for interest rates would be likely to rise, the sterling exchange rate to appreciate, UK focused equity prices to rise, and credit spreads would be likely to fall. It is not possible to estimate precisely how asset prices would change in the event of a smooth Brexit. However, information from surveys, as well as observing how asset prices have moved as no-deal betting odds have changed, can provide some illustrations. For example, the median responses to a Reuters survey in July suggested that in the month following any Brexit deal sterling would be expected to trade at a level between 4% and 9% higher against the dollar than it was in the run-up to the August Report.

The tables below provide stylised sensitivities of the MPC’s projections for growth and inflation to changes in asset prices. In illustrations with these particular constellations of asset prices, GDP growth and inflation would be expected to be lower. However, there is still significant excess demand at the end of the forecast period, which would boost inflation beyond that point.

These sensitivities leave all other assumptions unchanged from the MPC’s central projections. Those other assumptions could also adjust in response to Brexit developments. For example, households’ and companies’ spending would be affected by any changes in the perceived level of uncertainty about the future path of the economy.1

The economic outlook will depend significantly on the outcome of the UK’s withdrawal from the EU and how households, businesses and asset prices respond. As the MPC has previously communicated, the implications of Brexit developments for the appropriate path of monetary policy will depend on the balance of their effects on demand, supply and the exchange rate. Under all circumstances, the MPC will respond to any material change in the outlook to bring inflation sustainably back to the 2% target over time while — consistent with its remit — supporting jobs and activity.

  • 1. Box 5 in the February 2019 Inflation Report sets out some sensitivities of the MPC’s projections to movements in uncertainty as well as some asset prices.

Chart A

Sterling has depreciated as the perceived probability of a no-deal Brexit has risen
Sterling ERI and perceived probability of a no-deal Brexita

Chart A

  • Sources: Bank of England, Betfair and Bank calculations.

    a The implied probability is calculated from Betfair betting odds on leaving the EU in 2019 without a Withdrawal Agreement in place. Data from 11 April to 30 July 2019.

Table 1

The sensitivities of the MPC’s GDP growth, excess demand and inflation projections to given stylised changes in asset prices, holding everything else constant

Table 1

  • a Per cent of potential GDP.
    b Includes the impact of a 10 basis point fall in bank funding spreads, a 10 basis point fall in UK investment-grade non-financial corporate bond spreads, a 40 basis point fall in UK high-yield non-financial corporate bond spreads and a 7½% rise in UK-focused equity prices.
    c This row adjusts for the estimated endogenous response of other asset prices — particularly the exchange rate — to changes in the market path for Bank Rate. As a result, the component rows may not sum to the total impact.

Table 2

The sensitivities of the MPC’s GDP growth, excess demand and inflation projections to given stylised changes in asset prices, holding everything else constant

Table 2

  • a Per cent of potential GDP.
    b Includes the impact of a 20 basis point fall in bank funding spreads, a 20 basis point fall in UK investment-grade non-financial corporate bond spreads, an 80 basis point fall in UK high-yield non-financial corporate bond spreads and a 15% rise in UK-focused equity prices.
    c This row adjusts for the estimated endogenous response of other asset prices — particularly the exchange rate — to changes in the market path for Bank Rate. As a result, the component rows may not sum to the total impact.

Table 5.D Monitoring risks to the Committee’s key judgements

The Committee’s projections are underpinned by three 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 2019 Q3 to 2020 Q1 if judgements evolve as expected

1: while global activity has weakened and sentiment has deteriorated, looser financial conditions support the return of world growth to its potential rate in the medium term
  • Quarterly euro-area GDP growth to average a little above ¼%.
  • Quarterly US GDP growth to average around ½%.
  • Indicators of activity consistent with four-quarter PPP-weighted emerging market economy growth of around 4%; within that, GDP growth in China to average around 6%.
2: on the conditioning assumption that there is a smooth Brexit, UK demand growth recovers after softening in the near term
  • Business investment to fall by 1% per quarter, on average.
  • Quarterly real post-tax labour income growth to average around ¼%.
  • Quarterly consumption growth to average ¼%.
  • Mortgage approvals for house purchase to average about 65,000 per month.
  • The UK house price index to rise by just over 2% in the year to 2020 Q1.
  • Housing investment to fall by ¼% per quarter, on average.
3: as GDP growth recovers to above the subdued rate of potential supply growth, excess demand and domestic inflationary pressures build
  • Unemployment rate to remain around 3¾%.
  • Participation rate to remain around 64%.
  • Average weekly hours worked to remain around 32.
  • Quarterly hourly labour productivity growth to average ¼%.
  • Non-fuel import prices to rise by ¾% per quarter, on average.
  • Electricity and gas prices to drag on CPI inflation in 2019 Q4, as Ofgem’s energy price cap is assumed to be lowered.
  • Commodity prices and sterling ERI to evolve in line with the conditioning assumptions set out in this Report.
  • Four-quarter growth in whole-economy AWE regular pay to average around 3½%.
  • Four-quarter growth in whole-economy unit labour costs to average around 3%; growth in private sector regular pay based unit wage costs to average around 3½%.
  • Indicators of medium-term inflation expectations to continue to be broadly consistent with the 2% target.

Box 7 Other forecasters’ expectations

This box reports the results of the Bank’s most recent survey of external forecasters, carried out in July.1 On average, respondents expected four-quarter GDP growth to rise slightly over the next three years (Table 1), lower than the August Inflation Report forecast at the two and three-year horizons. Forecasters’ central projections for the unemployment rate implied a pickup over the next three years, on average, in contrast to the fall in the equivalent Inflation Report forecast.

External forecasters, on average, expected CPI inflation to remain at the 2% target (Table 1). This is below the August Inflation Report forecast at the two and three-year horizons.

External forecasters’ central projections for Bank Rate had fallen relative to three months ago, but by much less than the market-implied path for Bank Rate upon which the MPC’s projections are conditioned (Chart A). On average, external forecasters project Bank Rate to reach 1.4% in three years’ time, compared with a market path that reaches 0.6% at that point. This could be one reason why external forecasters’ projections for GDP growth and CPI inflation are lower than the August Inflation Report forecasts.

While central projections for Bank Rate have only fallen a little, the average probability that forecasters placed on a cut in Bank Rate to below 0.5% in a year’s time has more than doubled to 23%, from 11% three months earlier. And rises in Bank Rate were seen as a little less likely than in May (Chart B). As in recent surveys, almost all forecasters expected the current stock of gilt and corporate bond purchases to remain broadly stable over the next three years.

Table 1

Averages of other forecasters’ central projectionsa

Table 1

  • Source: Projections of outside forecasters as of 19 July 2019.

    a For 2020 Q3, there were 21 forecasts for CPI inflation, GDP growth and Bank Rate, 19 for the unemployment rate, 14 for the stock of gilt purchases, 10 for the stock of corporate bond purchases and 9 for sterling ERI. For 2021 Q3, there were 18 forecasts for CPI inflation and GDP growth, 17 for the unemployment rate and Bank Rate, 11 for the stock of gilt purchases, 7 for the stock of corporate bond purchases and 9 for sterling ERI. For 2022 Q3, there were 16 forecasts for CPI inflation, 15 for GDP growth, 14 for the unemployment rate, 15 for Bank Rate, 9 for the stock of gilt purchases, 5 for the stock of corporate bond purchases and 9 for 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

Forecasters’ projections of Bank Rate imply a steeper path than market interest rates
Market interest rates and averages of forecasters’ central projections for Bank Rate

Chart A

  • Sources: Bloomberg Finance L.P., projections of outside forecasters provided for Inflation Reports in May 2019 and August 2019 and Bank calculations.

    a Estimated using instantaneous forward overnight index swap rates in the 15 working days to 24 April and 24 July 2019 respectively.

Chart B

Forecasters placed a higher probability on lower levels of Bank Rate than three months ago
Average of forecasters’ probability distributions for Bank Rate in one year’s timea

Chart B

  • Sources: Projections of outside forecasters provided for Inflation Reports in May and August 2019.

    a Projections on the boundary of these ranges are included in the upper range, for example a projection of Bank Rate being 1.0% is in the 1.0% to 1.5% range.
This page was last updated 01 August 2019
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