The economic outlook

1.1 Recent developments

Underlying UK GDP growth has slowed materially over the past year.

While UK GDP growth has been volatile this year because of Brexit-related factors, underlying activity has weakened (Section 2). Quarterly growth over 2019 as a whole is expected to have averaged only 0.2%, roughly half the average in the previous three years and below the MPC’s assessment of the economy’s potential rate of growth.

That slowing has been driven partly by weakening global growth…

Subdued underlying UK GDP growth partly reflects the impact of weaker global growth. The world economy has experienced a marked, broad-based slowdown (Chart 1.1), and is now expanding at its slowest pace since 2009. The principal drivers of the slowdown are the rise in trade protectionism (Section 3), the impact of the past tightening in global financial conditions and domestic weakness in some large emerging market economies. Weak world activity has reduced demand for UK exports. Greater protectionism has increased global uncertainty, which is dampening investment spending in many countries, including the UK.

…and importantly by increasingly entrenched Brexit-related uncertainties.

UK spending has been materially dampened by increased uncertainties related to the Brexit process. In particular, the proportion of companies that report high uncertainty about Brexit has been elevated (Chart 1.2), and businesses on average expect Brexit to have a negative effect on their sales (Section 4). Those factors are likely to have weighed on business investment, which — unusually during an expansion — has fallen in five out of the past six quarters. Consumer spending has been more resilient to the uncertainties around Brexit, although these appear to have weighed on some discretionary spending and housing. While household spending has been underpinned by strong real income growth, consumption growth has weakened somewhat and the household saving rate has drifted up over the past couple of years, despite the strong labour market.

Chart 1.1 Global growth has slowed sharply

Four-quarter PPP-weighted GDP growth ^(a)

Chart 1.2 Uncertainty about Brexit has been elevated

Brexit in top three current sources of uncertainty (a)

A small margin of excess supply is judged to have emerged since the turn of the year.

The slowing in underlying GDP growth to below the MPC’s estimate of potential growth has led to a margin of slack opening up in the UK economy. The degree of spare capacity in the economy is judged to be modest, however.

CPI inflation has been close to the 2% target.

Inflation has been close to 2% in recent months, averaging 1.8% during 2019 Q3. Over the past year or so, inflation has fallen, accounted for by weaker goods price inflation, which in turn has been driven partly by the fading impact from sterling’s past depreciation. In contrast, core services price inflation has increased. That is consistent with a rise in domestic price pressures, and is likely to reflect the gradual pass-through of the strong pickup in pay growth over the past few years.

1.2 The MPC’s projections

The House of Commons has for the first time approved the second reading of a Bill to implement the Withdrawal Agreement agreed between the UK and EU.

On 17 October, a Withdrawal Agreement and Political Declaration on the framework for the future relationship between the UK and the EU was agreed, setting out a broad partnership with a free trade agreement at its core. On 22 October, the UK House of Commons approved the second reading of the Bill which is intended to implement the agreement in UK law. Reflecting those developments, the MPC’s projections are now conditioned on a transition to a deep free trade agreement (FTA) (Box 1). On 28 October, the UK’s EU membership was extended by up to a further three months to 31 January 2020.

The Withdrawal Agreement is likely to reduce near-term uncertainties…

The Brexit uncertainties that have been facing households, businesses and financial markets are assumed to decline gradually over the forecast period, leading to a pickup in household and especially business spending. The progress of the Withdrawal Agreement and the extension of the UK’s EU membership are likely to remove some uncertainty and support confidence in the near term, partly driven by a reduction in the risk of a no-deal Brexit. Some uncertainty is likely to persist, however, as the details of the UK and EU’s eventual relationship are assumed to emerge only gradually over time and the smoothness of the transition to it remains to be determined.

…and sterling has appreciated.

The fall in the perceived likelihood of a no-deal Brexit has also been associated with an appreciation of the sterling exchange rate, which has risen by around 4% over the past three months. As a result, the level of sterling is now more consistent with the MPC’s Brexit conditioning assumption. As the MPC set out in more detail in the August Report, UK asset prices reflect the probability market participants attach to the full range of possible Brexit outcomes, including a no-deal Brexit. That can lead to inconsistencies in the MPC’s forecasts, which do not include elsewhere the possibility that the UK leaves the EU without a deal. As a result, the possibility of a no-deal Brexit had weighed on sterling, pushing up the MPC’s earlier projections for GDP and inflation.

The projections are conditioned on the Government’s recent fiscal measures, which provide stimulus to demand.

The MPC’s projections are conditioned on the Government’s tax and spending plans, which include a large increase in planned spending, as announced in September as part of Spending Round 2019. All else equal, the increase in spending is expected to raise GDP by around 0.4% over the MPC’s forecast period. The projections are also conditioned on the market path for interest rates, which declines a little in the near term and ends the forecast period at around 0.5%. That accommodative path for monetary policy also supports the recovery in GDP growth.

Global GDP growth

Global GDP growth is expected to remain slow, as protectionism weighs on trade flows, business sentiment and investment, but picks up a little over the forecast period.

The MPC judges that some of the factors that have weighed on global activity over the recent past continue, such that global GDP growth is projected to remain at below-potential rates over coming quarters. Weakness in the euro area and some emerging market economies (EMEs) is expected to continue to restrain growth in the near term, with trade protectionism also acting as a drag. Protectionism weighs on trade flows directly and also indirectly through global uncertainty, business confidence and investment. Nonetheless, global growth is projected to pick up gradually over the forecast period, partly accounted for by a recovery in growth in some emerging economies. Growth is also supported by the loosening of monetary policy. In the central forecast, PPP-weighted world GDP growth gradually picks up from 3% in 2019 to 3½% in 2021 and 2022 (Chart 1.3). Weighted by UK export shares, world GDP growth is expected to pick up from 1¾% in 2019 to 2¼% in 2021 and 2022.

Weak global growth continues to weigh on UK export growth and investment.

Slow global growth is assumed to affect UK growth through trade channels, as well as via an effect on business spending. The higher uncertainty and lower sentiment associated with trade tensions weighs on UK business investment as well as that in other countries.

UK GDP growth

Growth of the UK’s supply capacity is subdued.

Potential productivity is projected to grow at around ¾% on average over the forecast period, although it picks up a little in the final year of the forecast period to around 1%. Productivity growth is very low relative to pre-crisis rates of around 2¼%, reflecting a continuation of the post-crisis trend, weak business investment and reduced openness as the UK transitions to its new trading relationship with the EU. Labour supply is assumed to grow by around ½% per year. As a result, total potential supply growth is subdued relative to historical rates, averaging around 1¼% over the forecast period, reaching 1½% by the end. Lower supply growth reduces the pace of GDP growth that is consistent with the MPC meeting its 2% inflation target.

Chart 1.3 Global growth is expected to recover somewhat over the forecast period

World GDP ^(a)

Chart 1.4 GDP projection based on market interest rate expectations, other policy measures as announced

UK demand growth is projected to recover over 2020.

Underlying UK demand growth remains a little below potential in the near term, but picks up during 2020 as the dampening effects from Brexit-related uncertainties begin to dissipate (Chart 1.4). That boosts business investment growth in particular. The pickup in GDP growth is also supported by easier fiscal policy and the gradual recovery in global growth. In the central forecast, UK GDP growth picks up from 1.0% in 2019 Q4 to 1.6% in 2020 Q4, 1.8% in 2021 Q4 and 2.1% in 2022 Q4 (Table 1.A).

Table 1.A Forecast summary ^(a)(b)

Four-quarter business investment growth picks up materially, from negative rates to around 4½% by 2022 (Chart 1.5). It is supported by the reduction in uncertainty, although slower global growth dampens investment spending. Household consumption rises broadly in line with real income growth over the forecast period as a whole. Consumption growth picks up from about 1% currently to 1½% in 2020, and 2% by 2022. On average over the forecast period, consumption grows somewhat more slowly than its historical pace, as real income growth is dampened by weak productivity growth. Both exports and imports growth fall as companies transition to the UK and EU’s new trading arrangements. On average over the forecast period, net trade weighs a little on growth.

Direct comparisons between the August and November projections are misleading because of inconsistencies in the August projections.

As explained in the August Report, the economic projections for growth and inflation at that time were mechanically boosted by the inconsistencies between asset prices and the Brexit conditioning assumption. Given that, comparisons between them and the MPC’s latest projections could be difficult to interpret. Specifically, asset prices had at that time factored in a significant probability of a no-deal no-transition Brexit, whereas the MPC’s economic projections did not include that possibility but rather were conditioned on the assumption of a smooth transition to the average of a range of possible outcomes for the UK’s eventual trading relationship with the EU.

The sharp fall in the perceived likelihood of a no-deal no-transition Brexit over the past three months, and the response of asset prices to that, means the inconsistencies within the August projections have been substantially reduced in the latest projections described in this Report. Consequently, direct comparisons of the two sets of projections could provide a misleading representation of how recent developments have affected the economic outlook over the past three months.

The outlook for global demand has weakened since the time of the August Report, for the reasons described above. Those developments will also have affected both UK and global asset prices over the past three months.

Since the August 2016 Report, the MPC’s projections have been conditioned on the assumption of a smooth transition to an average of possible end-states, with the adjustment taking place gradually over many years. Consistent with the provisions of the Withdrawal Agreement, the MPC’s latest projections are now conditioned on the assumption that a greater proportion of the adjustment to the UK’s new trading arrangements with the EU takes place within the three-year forecast period.

In the MPC’s latest projection, the level of GDP ends the forecast period around 1% lower than in August. Three quarters of that difference is accounted for by the moves in asset prices and the weaker global environment. The remaining quarter can be accounted for by the net impact of the changes to the MPC’s Brexit conditioning assumption described in Box 1 and the fiscal measures announced in Spending Round 2019. Table 1.B shows August projections adjusted for the impact of changes in asset prices and the world outlook since then.

Chart 1.5 Business investment growth is projected to pick up materially

Business investment ^(a)

Table 1.B Adjusted August 2019 projections ^(a)

Excess supply/demand

Slack is projected to remain in the first part of the forecast period, but, as GDP growth recovers, spare capacity is eroded and excess demand builds.

Some slack persists over coming quarters, but it is eroded as GDP growth picks up to above the subdued rate of potential supply growth around the middle of 2020. Excess demand emerges in 2021 and builds over the remainder of the forecast period, reaching 1¼% of potential GDP by the end (Table 1.A). The unemployment rate falls to around 3½% by the end of the forecast period (Chart 1.6).

CPI inflation

CPI inflation is projected to decline notably in the near term reflecting the impact of lower regulated energy and utilities prices…

Over the coming quarters, inflation will be affected by developments in a number of regulated prices. The price cap affecting household gas and electricity bills has fallen, which will reduce the contribution of energy prices to inflation, as will the fall in sterling oil prices over the past year. In addition, water bills are projected to fall in April 2020 in line with the draft determination of the regulator, Ofwat (Section 2). CPI inflation is expected to fall to an average of 1.2% in 2020 Q2 as a result.

…but further out inflation rises, supported by building excess demand.

Inflation picks up as those temporary effects begin to fade towards the end of 2020. It is supported by rising excess demand, which leads to stronger domestic inflationary pressures. Wage growth is projected to be around 3¾% over the second half of the forecast period, supported by low unemployment. Taken together with weak productivity growth, that means unit labour cost growth is robust. CPI inflation is projected to rise to 2.0% in the second year of the MPC’s forecast, and 2.2% in the third year (Chart 1.7).

Chart 1.6 Unemployment projection based on market interest rate expectations, other policy measures as announced

Chart 1.7 CPI inflation projection based on market interest rate expectations, other policy measures as announced

Policy decision

At its meeting ending on 6 November 2019, the MPC judged that the existing stance of monetary policy was appropriate. 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 page i of this Report and in more detail in the Minutes of the meeting.

Monetary policy could respond in either direction to changes in the economic outlook in order to ensure a sustainable return of inflation to the 2% target. The Committee would, among other factors, monitor closely the responses of companies and households to Brexit developments as well as the prospects for a recovery in global growth. If global growth failed to stabilise or if Brexit uncertainties remained entrenched, monetary policy might need to reinforce the expected recovery in UK GDP growth and inflation. Further ahead, provided these risks did not materialise and the economy recovered broadly in line with the MPC’s latest projections, some modest tightening of policy, at a gradual pace and to a limited extent, might be needed to maintain inflation sustainably at the target.

1.3 Key judgements and risks

Key Judgement 1: global GDP growth is projected to remain slow in the first part of the forecast period, partly reflecting the impact of trade protectionism, before rising gradually towards potential rates.

GDP growth is projected to continue to be slow in the near term, particularly in the euro area and some EMEs, in part reflecting the impact of trade tensions.

The MPC judges that protectionism is likely to continue to weigh on GDP growth both directly through its effects on trade flows, and through its indirect effects on uncertainty, business sentiment and investment (Section 3). The risks around the MPC’s judgement about the impact of protectionism are two-sided. Some of those risks relate to the extent of trade barriers — for example, the projections assume that no further trade barriers are announced, but they also assume that no existing tariff increases are rolled back. In addition, the estimates of their effects on economic activity are uncertain. There is a chance that the indirect effects could be bigger, consistent with some investors’ views that a trade war is the top risk to the global outlook (Section 3). Nonetheless, the projections include relatively sizable indirect effects, including in the euro area, where growth is judged likely to be dampened by concerns that further tariffs could be introduced, as well as through spillover effects from the impact of tariffs on Chinese demand.

The MPC projects that global growth will recover a little, with the risks around the outlook broadly balanced.

While trade protectionism continues to weigh on activity, global growth begins to pick up a little during 2020. That pickup is partly accounted for by a recovery in growth in some emerging economies, which have been hit by idiosyncratic shocks, for example in Turkey and Argentina. It is also supported by the loosening of monetary policy. There is a risk that the interest rate required to boost demand and return inflation sustainably to target rates has declined somewhat, however, due to higher levels of uncertainty.

The MPC judges that the risks around the global growth projection are broadly balanced.

Key Judgement 2: supply growth is subdued.

Supply growth has been further restrained by the impact of uncertainty.

The MPC judges that potential supply growth is likely to have been restrained somewhat recently by Brexit weighing on potential productivity growth. That might have occurred through lower business investment reducing capital deepening. In addition, preparations for Brexit are likely to have diverted resources away from productive output or making improvements. The resources devoted to Brexit preparations have increased in 2019.

As a result, the degree of slack that has opened up over the past year might be a little less than would have been implied by the weakening in demand growth alone. That is consistent with the fact that unemployment has remained low, and below the MPC’s estimate of its equilibrium rate. Slack is assumed to lie within companies, consistent with some survey measures of capacity utilisation.

Productivity growth remains very low.

The MPC judges that productivity growth will pick up a little over the forecast period, but will remain well below its pre-crisis pace. That limits the rate at which the economy can grow without putting upward pressure on inflation. The MPC’s projection of subdued productivity growth reflects a continuation of the post-crisis trend, recent weakness in business investment and the reduction in openness that occurs as the UK economy adjusts to its new trading arrangements with the EU.

These judgements are subject to risks in both directions. While the empirical relationships between openness, trade and productivity are well founded (Box 1), the size of the effects are naturally uncertain. In addition, until the details of the FTA are finalised, there will be uncertainty about the barriers to trade that will arise and when exactly they will take effect.

Moreover, there are very few recent historical examples of trading relationships becoming less aligned. As such, the estimated impact on trade flows of joining trading arrangements is assumed to be a proxy for the size of the impact of leaving them. It is possible that the size of these effects could be different, however. On the one hand, the impact of trade barriers going up might be smaller than when they go down as the trading relationships are already well established. On the other hand, estimates of the average impact across a wide number of countries might understate the impact of a large, advanced and heavily integrated country leaving an existing trading arrangement.

There are also substantial uncertainties around the timing of the effects. The pace at which increased barriers impact trade flows is likely to depend on the types of barriers that take effect. While some barriers are likely to affect trade quite quickly — for example, customs declarations that take additional time and cost to complete — the effect of others is likely to occur more slowly — for example regulations and product standards between the EU and UK are expected to diverge only gradually over time.

The MPC judges that the risks around its projections for potential supply growth — and therefore GDP growth — are skewed to the downside in the second and third years of the forecast, reflecting the uncertainty around the exact nature of the FTA with the EU and the transition to it.

Key Judgement 3: uncertainty is reduced by the Withdrawal Agreement — providing some support to UK demand growth.

The strength of the pickup in growth will depend importantly on how households and businesses respond to the Withdrawal Agreement.

The Withdrawal Agreement and extension of the UK’s membership of the EU appears to have reduced Brexit-related uncertainty. In part that reflects some decline in the likelihood of a no-deal Brexit. There is substantial evidence that perceptions of the risk of a no-deal Brexit have declined. Sterling has appreciated, betting odds on a no-deal Brexit in 2019 have fallen and responses to the DMP Survey suggest that the average likelihood that firms attach to that outcome fell after the second reading of the Withdrawal Agreement Bill was passed. The expected fall in uncertainty is projected to boost investment and, to a lesser extent, consumption. Four-quarter business investment growth is projected to pick up from -1½% in 2019 Q2 to 4% in 2021, which drives a recovery in GDP growth over that period. Nonetheless, it is restrained by weak productivity growth and slow global growth.

There are two-sided risks to the outlook for business investment. A greater drag from Brexit uncertainty could persist in the near term if businesses judge that they continue to need greater clarity about the specific details of the UK’s future trading relationship and the speed of the adjustment to it. Alternatively, there could be a bigger rebound in investment if companies bring back a larger number of previously paused projects.

Spending growth will also be sensitive to how households respond to uncertainty. The saving ratio and household financial balance have drifted up a little over the past couple of years, which might suggest that households have undertaken some precautionary savings in response to higher uncertainty. Historically, households’ savings have increased mainly in response to higher concerns about their job prospects.

Over the forecast period as a whole, household consumption is projected to grow broadly in line with real income growth. Households’ confidence and spending should be supported by unemployment remaining low. Nonetheless, there are risks around those judgements.

The risks around the UK growth forecast are judged to be skewed to the downside, reflecting the downside risks to supply growth.

The outlook for GDP growth will also be sensitive to developments in the UK’s supply capacity. Productivity growth in the economy impacts demand by affecting the income that households have to spend and the incentive for companies to invest. Reflecting the risks around the forecast for potential supply growth, the MPC judges that the risks to UK GDP growth are skewed to the downside in the second and third years of the forecast, reflecting the uncertainty around the exact nature of the FTA with the EU and the transition to it.

Key Judgement 4: CPI inflation declines further below 2% in the near term given lower utilities prices, before rising slightly above the target by the end of the forecast owing to building domestic price pressures.

The projected decline in CPI inflation in the near term is expected to be temporary.

While CPI inflation is projected to decline in the near term, that fall is expected to be temporary, given it reflects the impact of changes in some regulated prices (Section 2). Inflation is projected to fall to 1.2% on average in 2020 Q2 — and the chance that it falls below 1% is judged to be a little less than a half at that point. However, as the effects of past changes in utilities prices drop out of the annual calculation, inflation is projected to return towards the 2% target.

As excess demand builds, domestic price pressures rise.

The pickup in inflation is supported by the move from excess supply into excess demand. Throughout the forecast period, unemployment is projected to be low and wage growth is projected to be relatively strong. With weak productivity growth, domestic cost growth remains solid and those higher costs are assumed to be passed through to CPI inflation. It is possible that consumer-facing companies continue to absorb some of the higher cost pressures in their profit margins so domestic price pressures remain subdued. Alternatively, margins could be maintained or rebuilt as excess demand rises, leading to domestic price pressures increasing more rapidly.

CPI inflation ends the forecast period a little above the target.

Domestically generated inflation is projected to exert upward pressure on CPI inflation over the second half of the forecast period, such that CPI inflation is at 2% in 2021 Q4 and ends the forecast a little above the MPC’s target.

The risks around the MPC’s projection for inflation are judged to be broadly balanced.

The risks to the MPC’s inflation forecast are judged to be broadly balanced. In addition to the risks arising from demand, supply, and pricing conditions, the outlook for CPI inflation will also be affected by movements in sterling, which is likely to remain sensitive to Brexit developments.

1.4 Constant rate projections

In the MPC’s projections conditioned on the alternative assumption of constant interest rates at 0.75%, GDP growth is slightly weaker, but still recovers to outstrip the subdued rate of supply growth (Chart 1.8). As a result, excess demand builds over 2021 and 2022. CPI inflation ends the forecast period slightly above the target at 2.1% (Chart 1.9).

Chart 1.8 GDP projection based on constant nominal interest rates at 0.75%, other policy measures as announced

Chart 1.9 CPI inflation projection based on constant nominal interest rates at 0.75%,^{footnote [1]} other policy measures as announced

Table 1.C Indicative projections consistent with the MPC’s forecast ^(a)(b)