Current economic conditions

2.1 Global developments and financial conditions

Global growth has slowed over the past two years.

Global output growth has slowed markedly since 2017. Four‑quarter PPP‑weighted global growth was 2.8% in the year to 2019 Q3, down from 3.9% in 2017 Q4. The slowdown in global growth has been broadly based across regions (Chart 2.2). It has been particularly apparent in the manufacturing sector — annual growth in industrial production was 0.3% in November, down from around 4% in 2017. This is likely to reflect in part the impact of increased trade protectionism. It also reflects the ongoing slowdown in China, which has also dragged on growth in countries that rely on Chinese demand.

Chart 2.2 The slowdown in global growth has been broadly based across regions

Change in four‑quarter GDP growth rates between 2017 Q4 and 2019 Q3 ^(a)

Sources: Eikon from Refinitiv, Eurostat, IMF World Economic Outlook (WEO), Japanese Cabinet Office, National Bureau of Statistics of China, ONS, Statistics Canada, US Bureau of Economic Analysis and Bank calculations.

(a) Chained‑volume measures.
(b) Other EMEs and other advanced economies (AEs) include data for 154 and 11 countries, respectively, as defined by the IMF WEO. Both measures are weighted according to their shares in world GDP, using the IMF’s purchasing power parity (PPP) weights.

Chart 2.3 US‑China tariffs are lower than expected in the November Report

Weighted average tariff rates ^(a)

Sources: Ministry of Commerce of the People’s Republic of China, Office of the United States Trade Representative and Bank calculations.

(a) Estimates of tariff rates are shown to December 2019.

Since November, trade tensions have eased…

Global trade tensions have eased somewhat since the November Report. In December, the US and China announced the preliminary details of the first phase of a trade deal, in which tariffs due to be implemented on 15 December 2019 would not go ahead and some existing tariffs would be reduced. This ‘Phase One’ deal was signed in January, with China also pledging to increase its imports of US goods. These actions have reduced effective bilateral tariff rates between the US and China by around 4–5 percentage points relative to what was assumed in November (Chart 2.3). As a result, the direct effects of tariffs on global output are estimated to be marginally less than outlined in Section 3 of the November Report, subtracting around 0.3% from PPP‑weighted GDP. Uncertainty around future trade policy is likely to remain elevated, however. The US has suggested that new tariffs might be imposed on goods imported from other countries since November. The estimated size of the indirect effects of trade barriers through uncertainty and business confidence are unchanged relative to November, at around 0.7% of PPP‑weighted GDP.

…and there are some signs that global growth has stabilised.

There has been some positive news in the official data since November. Quarterly growth in the euro area was a little stronger than expected in Q3. In the US, stronger‑than‑expected net trade and residential investment means that GDP is now expected to have increased by 2.4% in the four quarters to Q4, higher than previously projected. Quarterly growth in non‑China emerging market economies (EMEs) was slightly stronger than expected in Q3, although downward revisions to previous estimates mean that four‑quarter growth is a little weaker than projected in November. In China, four‑quarter growth remained at 6.0% in 2019 Q4, in line with expectations in the November Report.

Other indicators of global growth have also shown signs of stabilisation. Three‑month on three‑month growth in world goods trade was -0.2% in November, similar to August. Growth in advanced‑economy capital goods orders has recovered somewhat, although it remained marginally negative in November.

There has been a recovery in timely survey data, such as global purchasing managers’ indices (PMIs), since the November Report. Having fallen previously, the global composite and services PMIs have risen a little while the manufacturing PMI has returned to expansionary territory (Chart 2.4). The manufacturing new export orders index remains below the 50 ‘no change’ mark, but it has recovered slightly in recent months.

Taken together, quarterly growth in PPP‑weighted GDP is expected to have picked up slightly in Q4. Four‑quarter growth is also expected to have risen a little to 2.9% (Chart 2.5), broadly in line with the projection in November. It is expected to increase further in the near term to 3.2% in 2020 Q2, slightly stronger than expected in the November Report (Table 2.D).

Chart 2.4 Global PMIs suggest growth is stabilising

Global purchasing managers’ indices ^(a)

Sources: Eikon from Refinitiv, IHS Markit and JPMorgan.

(a) Measures of current monthly composite (services and manufacturing) output, manufacturing, services business activity and manufacturing new export orders growth based on the results of surveys in 44 countries. Together these countries account for an estimated 89% of global GDP. Latest data are for December 2019.

Chart 2.5 Global growth is expected to pick up slightly in 2019 Q4

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

Sources: Eikon from Refinitiv, IMF WEO and Bank calculations.

(a) Constructed using real GDP growth rates of 189 countries according to their shares in world GDP using the IMF’s PPP weights. Diamonds show Bank staff’s projections for growth in 2019 Q4.

Global inflation remains muted…

In the majority of advanced economies, inflation has been 2% or below in recent years (Chart 2.6). Inflation has been particularly weak in the euro area where, despite a rise in unit labour cost growth since 2017, core inflation has averaged around 1% over 2019. Core inflation has picked up a little in recent months, however (Table 2.A). In the US, where unit labour cost growth has also been strong, core inflation was 1.6% in November.

Alongside subdued inflation, market‑based measures of inflation expectations in the US and euro area fell over 2019. These have recovered somewhat in recent months, however (Chart 2.28).

…and policy is expected to remain accommodative.

In 2019, monetary policy was eased by a number of central banks, including the US Federal Reserve and the European Central Bank (Chart 2.7), in response to a weakening outlook for growth. A number of central banks in emerging market economies also loosened policy.

Since the November Report, market‑implied paths for interest rates in some advanced economies have increased marginally (Chart 2.7), but monetary policy is expected to remain accommodative. There has been some further policy loosening in China, with the People’s Bank of China reducing the reserve requirement ratio for banks in January. These factors, combined with somewhat supportive fiscal policy in China and the euro area, are expected to continue to support growth (Section 1).

Chart 2.6 Inflation is subdued across advanced economies

Annual consumer price inflation across advanced economies ^(a)

Sources: World Bank: World Development Indicators and Bank calculations.

(a) Consumer prices for 36 advanced economies. Data are available until 2018. Countries with inflation on the bounds of these ranges are placed within the lower range.

Table 2.A Inflation has been particularly weak in the euro area

Inflation in selected economies

Sources: Eikon from Refinitiv, Eurostat, US Bureau of Economic Analysis and Bank calculations.

(a) Personal consumption expenditure price index inflation.
(b) For the euro area and the UK, excludes energy, food, alcoholic beverages and tobacco. For the US, excludes food and energy.

Global asset prices have responded positively to these developments.

Since the November Report, international risky asset prices have rallied. Global equity prices have risen (Chart 2.8), and high‑yield corporate bond spreads have narrowed. The moves in risky asset prices have largely been driven by a fall in risk premia, reflecting a perceived reduction in the downside risks to growth. Expectations that monetary policy will remain accommodative may also have played a role. The rise in risky asset prices has occurred despite an apparent rise in geopolitical risks since November: the Federal Reserve’s geopolitical risk index has picked up. Since the MPC’s projections were finalised, global equity prices have fallen somewhat, as concerns over coronavirus have risen.^[1]

Chart 2.7 Monetary policy is expected to remain accommodative

International forward interest rates ^(a)

Sources: Bloomberg Finance L.P. and Bank calculations.

(a) All data as of 22 January 2020. The January 2020 and November 2019 curves are estimated using instantaneous forward overnight index swap rates in the 15 working days to 22 January 2020 and 30 October 2019 respectively.
(b) Upper bound of the target range.

Chart 2.8 Global equity prices have strengthened as perceived downside risks to growth have declined

International equity prices ^(a)

Sources: Eikon from Refinitiv, MSCI and Bank calculations.

(a) In local currency terms, except for MSCI Emerging Markets which is in US dollar terms.
(b) The MSCI Inc. disclaimer of liability, which applies to the data provided, is available from the ‘Download the chart slides and data’ link.

Sentiment in UK financial markets has been boosted further by political developments…

While UK asset prices have probably been influenced by these global factors, domestic political developments appear to have been the main driver of recent moves. Ahead of the general election on 12 December, market prices reflected uncertainty about the range of potential options for Brexit, as well as future government policy. The election result has reduced some of those uncertainties, especially in the near term. Implied volatilities from sterling options — which capture perceived uncertainty around the exchange rate — have fallen by more than 30% at the three‑month horizon since the November Report (Chart 2.9), and are now much closer to other currency pairs.

Chart 2.9 Near‑term sterling implied volatility has fallen considerably

Three‑month implied volatilities ^(a)

Sources: Bloomberg Finance L.P. and Bank calculations.

(a) Measures of volatility based on option contracts.

Chart 2.10 Sterling has appreciated by around 1½% since the November Report

Sterling ERI

The fall in longer‑term implied volatility has been less pronounced, however, and volatilities at all maturities remain higher relative to the US dollar‑euro currency pair. This may reflect ongoing uncertainty about the nature of the eventual trading relationship between the UK and the EU.

…boosting asset prices and lowering bond spreads.

The decline in uncertainty has been reflected in asset prices and bond spreads. Sterling was volatile in the days immediately following the election, but was around 1½% higher in the run‑up to the January Report compared to the November Report (Chart 2.10). UK equity prices have also strengthened — particularly for UK‑focused companies whose equity prices have risen 8% on average — and borrowing spreads have fallen (Chart 2.11). For overall monetary and financial conditions, the rise in equity prices and the decline in borrowing spreads have broadly offset the tightening effect from sterling’s appreciation since the November Report (Chart 2.12).

Chart 2.11 Reduced uncertainty has supported equity prices and lowered bond spreads

UK equity prices and corporate bond spreads

Sources: Bloomberg Finance L.P., Eikon from Refinitiv, ICE/BoAML Global Research and Bank calculations.

(a) UK domestically focused companies are defined as those generating at least 70% of their revenues in the United Kingdom.
(b) Based on option‑adjusted spreads between government bond yields and non‑financial corporate bonds.

Chart 2.12 Overall monetary and financial conditions in the UK are broadly unchanged

Contributions to changes in the UK Monetary and Financial Conditions Index since the November 2019 Report ^(a)

Sources: Bloomberg Finance L.P., Eikon from Refinitiv, ICE/BoAML Global Research and Bank calculations.

(a) The UK Monetary and Financial Conditions Index (MFCI) summarises information from the following series: short‑term and long‑term interest rates, the sterling ERI, corporate bond spreads, equity prices, and household and corporate bank lending spreads. The series weights are based on the marginal impact of each variable on the UK GDP forecast. The chart shows changes in the MFCI from the average level over the 15 working days to 30 October 2019. An increase in the MFCI signals tighter financial conditions and a decrease signals looser conditions. For more information, see the Bank Overground post ‘How can we measure UK financial conditions?’.

2.2 Demand and output

UK GDP growth has slowed materially…

Quarterly UK GDP growth rates throughout 2019 have been affected by temporary, mainly Brexit‑related, factors including stockbuilding and car factory shutdowns (Chart 2.13). UK GDP grew by 0.4% in Q3, in line with the November Report estimate (Chart 2.1).

Growth in Q4 is then expected to have slowed to zero, based on official data to November, weaker than the 0.2% projection in the November Report. An important factor behind the slowing has been a further weakening in service sector output, which grew by just 0.1% in the three months to November. Manufacturing output declined by 0.8% over the same period, and fell by almost 2% on an annual basis.

Abstracting from quarterly volatility, GDP is expected to have grown by around 0.2% a quarter on average in 2019, slower than the average of around 0.4% over the previous three years (Chart 2.14).

Chart 2.13 Quarterly GDP growth has been volatile

Estimated contributions of various factors to quarterly GDP growth ^(a)

Sources: ONS and Bank calculations.

(a) Chained‑volume measures. 2019 Q4 is Bank staff’s projection. The contributions of idiosyncratic factors are estimated by Bank staff.
(b) GDP fell by 0.4% in December 2018 before rising by 0.6% in January 2019.

Chart 2.14 Growth has slowed on average compared to previous years

Quarterly GDP growth ^(a)

Sources: ONS and Bank calculations.

(a) Chained‑volume measure. The hollow bars in 2019 Q4 and 2020 Q1 are Bank staff’s projections.

…dampened by the global slowdown and Brexit‑related uncertainty…

Some of the weakening in growth — particularly in the manufacturing sector — reflects the slowdown in global growth (Chart 2.2). A simple model using the average relationship between UK growth and growth in other advanced economies would be consistent with a slowing in UK GDP growth over the past few years. But, on average, quarterly UK growth since 2016 has been around 0.2 percentage points lower than would be suggested by this model. Brexit‑related uncertainty is an important potential explanation for this (see Section 4 of the November Report).

…resulting in a margin of spare capacity in the economy.

As Section 4 describes, the MPC judges that weak GDP growth has resulted in a margin of spare capacity in the economy, despite some of the slowdown reflecting a reduction in potential supply growth. Spare capacity is judged to lie within firms, as the labour market remains tight (Section 3).

Growth in 2020 Q1 is expected to remain around its 2019 average.

Evidence from all the available survey data would be consistent with broadly flat GDP in 2020 Q1, based on their historical relationship. A range of output surveys deteriorated further throughout 2019 Q4. But many of these surveys were taken before the general election, when uncertainty was elevated. Survey‑based estimates of GDP growth have been below official data for much of the past year (Chart 2.15), consistent with a weaker relationship with GDP growth during times of heightened uncertainty (see Box 3 in the February 2019 Inflation Report).

The few surveys which have been taken since the general election have picked up. The latest CBI Industrial Trends Survey did not suggest a marked pickup in manufacturing output, but business confidence increased sharply. The output and expectations balances in the flash IHS Markit/CIPS survey picked up significantly in January (Chart 2.16). The January IHS Markit/CIPS output data alone would be broadly consistent with GDP growth of around 0.2% in Q1, and expectations data suggests growth could be stronger still.

Overall, Bank staff expect GDP to grow by 0.2% in 2020 Q1, close to its 2019 average.

Chart 2.15 Survey data have suggested a weaker picture for GDP growth in 2019 than official data, similar to 2016

Quarterly GDP growth and estimates using survey data

Sources: BCC, CBI, IHS Markit/CIPS, Lloyds Banking Group, ONS and Bank calculations.

(a) Dashed lines for GDP growth in 2019 Q4 are Bank staff’s projection.
(b) Survey‑based estimates are Bank staff’s projections for GDP growth using only survey indicators of output and expectations covering the period until the end of the projection quarter.

Chart 2.16 The IHS Markit/CIPS survey output and expectations indices have been weak but picked up markedly in January

Survey indicators of current and expected output growth ^(a)

Sources: IHS Markit/CIPS and Bank calculations.

(a) Differences from averages since January 2000. UK composite output and expectations indices. Data for January 2020 are flash estimates with sample period from 13 to 22 January.

Growth is likely to pick up if there is a sustained fall in uncertainty…

The result of December’s general election has reduced the uncertainty about future government policy and early evidence suggests measures of uncertainty have fallen since the November Report. Alongside falls in sterling implied volatility (Chart 2.9), the proportion of firms citing Brexit as one of their top three sources of uncertainty fell to below 45% in the Bank’s January Decision Maker Panel (DMP) Survey, compared to 55% in November (Chart 2.17). The fall in uncertainty was also apparent in the Deloitte CFO Survey, where the number of firms reporting high or very high uncertainty almost halved. Despite the recent fall, levels of Brexit‑related uncertainty remain higher than those seen two years ago.

The reduction in uncertainty is likely to support growth, but the effect will depend on how quickly spending by firms and households responds.

…as it has been weighing heavily on business investment…

As discussed in Section 4 of the November Report, higher uncertainty has weighed on business investment as it has provided an incentive for firms to delay spending. Business investment growth has continued to be weak over 2019, although recent revisions suggest that growth has picked up a little. It is currently estimated to have grown by 0.5% in the 12 months to 2019 Q3, the first positive annual growth rate for over a year (Chart 2.18). Investment in transport warehousing, which may have been needed for Brexit contingency planning, has been notably strong over the past two years. Overall though, business investment has grown by only 1.5% since 2016 Q2, compared to 12% on average for other countries in the G7.

There is so far limited evidence about the extent to which the recent decline in uncertainty will boost investment. Intelligence from the Bank’s Agents and aggregate CBI survey data suggests that few companies have materially increased their planned investment spending as yet, but these data include responses from before the election. Respondents to the recent Deloitte CFO and CBI manufacturing surveys, which were conducted after the election, reported that their investment intentions had risen (Chart 2.19). Recent DMP data also pointed to a modest pickup in expected investment growth over the coming year.

Chart 2.17 Brexit‑related uncertainty has fallen back a little but remains elevated

Brexit in top three current sources of uncertainty and CFOs reporting high uncertainty

Sources: Decision Maker Panel (DMP) Survey, Deloitte and Bank calculations.

(a) Question: ‘How much has the result of the EU referendum affected the level of uncertainty affecting your business?’. Respondents can select: ‘Not important’; ‘One of many sources’; ‘Two or three top sources’; or ‘Top source of uncertainty’. Before August 2018, data are interpolated between waves and shown as three‑month rolling averages. The DMP currently consists of around 8,000 businesses with around 3,000 responses a month being received. The sample period for the January DMP was 3 to 17 January.
(b) Question: ‘How would you rate the general level of external financial and economic uncertainty facing your business?’. Series shows the proportion of respondents which selected ‘high’ or ‘very high’. Not seasonally adjusted. 119 CFOs responded to the 2019 Q4 survey and the sample period was 16 December to 6 January.

Chart 2.18 Business investment growth remains weak, despite a slight pickup in the latest data

G7 business investment

Sources: Eikon from Refinitiv, Japanese Cabinet Office, OECD, ONS, Oxford Economics, Statistics Canada, US Bureau of Economic Analysis and Bank calculations.

(a) Business investment is not an internationally recognised concept. This swathe is based on similar series derived from other countries’ National Accounts. Private sector business investment for Italy. Business investment minus residential structures for Canada. Non‑residential private investment for Japan and the US. Non‑government investment minus dwellings investment for France and Germany.
(b) Chained-volume measure.

…and may have dampened household spending.

Consumption growth has slowed over the past year. It has been lower than real wage growth (Chart 2.20). This may reflect a delay before changes in income affect spending, but the widening of the gap between the two could also suggest households have been more cautious about spending in the face of Brexit‑related uncertainty. Nonetheless, household consumption growth has been more resilient to uncertainty than investment and continued to grow at 0.3% in 2019 Q3. It has been supported by low unemployment (Chart 2.1) and, more generally, by a strong labour market (Section 3).

Chart 2.19 Investment intentions have been subdued, but some surveys suggest they have picked up in the latest data

Selected survey indicators of investment intentions ^(a)

Sources: Bank of England, CBI, CBI/PwC, Deloitte and Bank calculations.

(a) Differences from averages since 2000 or earliest available data. The Agents’ scores for 2020 Q1 are January scores and were collected in the six weeks to 8 January. The sectors within CBI (manufacturing, distribution, financial services and business/consumer/professional services) are weighted together using shares in real business investment and show planned investment in plant and machinery. The survey periods for 2019 Q4 CBI data were 16 December to 13 January for manufacturing and before the general election for other sectors. Deloitte data (expected changes in capital expenditure) are available from 2010 Q3. The sample period for the 2019 Q4 Deloitte data was 16 December to 6 January.

Chart 2.20 Consumption growth has been weaker than real wage growth, suggesting households may have been cautious about spending

Household consumption and real wages ^(a)

Sources: ONS and Bank calculations.

(a) Real wages are whole‑economy real average weekly earnings (excluding bonuses) multiplied by whole‑economy employment.

More timely indicators have provided mixed signals for how consumption has evolved in 2019 Q4. Retail sales fell by 1%, the joint weakest quarterly growth rate since 2010, but these data tend to provide a less accurate read on consumption, on average, than other indicators such as consumer confidence and house prices.

Consumer confidence has improved a little since the November Report. Household confidence in their personal financial situation and expectations for unemployment were back to their long‑run averages in the December GfK/EC survey (Chart 2.21). While expectations for the general economic situation still remain some way below their long‑run average, they have improved materially since November.

House price growth has also strengthened in the latest data. Annual house price growth picked up to 1.7% in the three months to November, up from 1.1% in August. Expectations for house price growth also rose sharply in the December RICS survey to well above historical averages.

Taken together, these indicators for 2019 Q4 suggest consumption growth will remain at 0.3%.

A stabilisation in global growth will support UK trade and business investment.

Stockbuilding by UK and EU companies ahead of the March and October Brexit deadlines has heavily influenced UK trade flows. Goods exports to and imports from the EU picked up in the run‑up to the March deadline, before rapidly falling in Q2 (Chart 2.22). Stockbuilding ahead of the October deadline produced a similar pattern but on a smaller scale.

Abstracting from the effects of stockbuilding, the slowdown in global growth has weighed on UK growth by dampening business investment and demand for UK exports. UK goods exports to countries outside the EU rose sharply in the second half of 2019 (Chart 2.22), pushing up export growth and contributing to the recent trade surplus. This growth has fallen back in the most recent data however. Global growth has shown signs of stabilisation (Section 2.1) and is projected to recover (Section 1), which should support UK trade and business investment.

Chart 2.21 Household confidence has picked up a little since the November Report

Indicators of consumer confidence ^(a)

Sources: GfK (research carried out on behalf of the European Commission) and Bank calculations.

(a) Differences from averages since 1997. The December 2019 sample period was 2–11 December.
(b) Net balance of respondents expecting that the number of people unemployed will rise over the next 12 months.
(c) Net balances of respondents expecting an improvement over the next 12 months.

Chart 2.22 Trade data have been volatile

Contributions to three‑month on three‑month growth in imports and exports, by type ^(a)

Sources: ONS and Bank calculations.

(a) Chained‑volume measures. Goods exports and imports are measured excluding trade in unspecified goods.

Growth should be supported by broadly accommodative credit conditions…

Household credit conditions remain accommodative. Mortgage rates have been broadly flat since the November Report and remain low (Table 2.B). Credit card quoted rates have risen but the effective rate paid by the average borrower has remained flat. The quoted rate on overdrafts has also increased but this has been accompanied by lower fees, reflecting lenders’ responses to Financial Conduct Authority regulations requiring simpler pricing structures.

Since the November Report, there have been some further signs of tightening in corporate credit conditions. Reported corporate credit availability fell in the Q4 Credit Conditions Survey and banks expect further tightening in Q1 across all firm sizes (Chart 2.23). Firms in the construction, property and retail sectors still appear to be most affected, but intelligence from the Bank’s Agents suggests that lenders have also modestly tightened criteria for other sectors. Net finance raised by private non-financial corporations (PNFCs) was weak in October and November but this follows particularly strong volumes in September. Looking at annual growth rates, the reported tightening in credit availability does not yet appear to have materially affected lending volumes.

Table 2.B Mortgage rates remain low

Selected household lending and deposit quoted rates ^(a)

(a) The Bank’s quoted rate series are weighted monthly average rates advertised by all UK banks and building societies with products meeting the specific criteria. Not seasonally adjusted.
(b) January 2020 data are flash estimates using data to 22 January and are subject to change until they are published on 7 February.
(c) In February 2019 the method used to calculate these data was changed. See ‘Introduction of new Quoted Rates data’ for more information.

Chart 2.23 Corporate credit conditions tightened in Q4

Availability of credit to corporates reported by lenders in the Credit Conditions Survey ^(a)

(a) Weighted by market shares. A positive balance indicates that more credit is available. Diamonds show net percentage balances for the expected change over the next three months, these have been moved forward by one quarter so that they can be compared with the actual outcomes in the following quarter.

…as well as higher government spending.

Government spending has provided support for growth in 2019. Central government spending in cash terms was 3.3% higher between April and December 2019 compared to the same period a year earlier. The latest government spending plans were announced in September, as part of Spending Round 2019. All else equal, the increase in spending announced then is expected to raise GDP by around 0.4% over the MPC’s three‑year forecast period. The Government has announced that the 2020 Budget will take place on 11 March.

2.3 Costs and prices

CPI inflation has slowed over the past year, driven by falls in energy prices.

CPI inflation fell to 1.4% on average in 2019 Q4, down from 2.3% in 2018 Q4. This fall has been driven largely by a decline in the contribution from energy prices (Chart 2.24). This partly reflects a decline in fuel prices: sterling oil prices were around 8% lower in 2019 Q4 compared to 2018 Q4 (Chart 2.25). The decline in the contribution from energy prices also reflects cuts to Ofgem’s energy price caps, which came into effect in October, reducing electricity and gas prices by 3% and 9% respectively for the typical default tariff customer. Core inflation, which excludes the effects of energy prices and some other volatile components, has also slowed a little over the year, and was 1.6% on average in Q4.

CPI inflation is expected to pick up in 2020 Q1, but fall to 1.3% in 2020 Q2, driven by changes in regulated prices.

CPI inflation is expected to pick up a little in 2020 Q1 to 1.8%, before falling back to 1.3% in 2020 Q2 (Chart 2.24). Much of this volatility is driven by changes to Ofgem’s energy price cap. CPI inflation will be boosted in Q1 as the January 2019 price cap cut drops out of the annual comparison. Similarly, the April 2019 rise will drop out of the annual calculation in 2020 Q2 and pull down inflation. The fall in the wholesale gas futures curve since the November Report (Chart 2.25) means that the energy price cap is now expected to decrease by more in April 2020, providing a further drag on inflation in 2020 Q2.

Chart 2.24 The fall in inflation over 2019 has been driven largely by energy prices

CPI inflation, core CPI inflation and the contribution of energy

Sources: Bloomberg Finance L.P., Department for Business, Energy and Industrial Strategy, ONS and Bank calculations.

(a) Bank staff’s projection. Fuels and lubricants estimates use Department for Business, Energy and Industrial Strategy petrol price data for January 2020 and are then based on the sterling oil futures curve.
(b) CPI inflation excluding food, energy, alcohol, tobacco and non‑alcoholic beverages.

Chart 2.25 Oil prices have increased since the November Report

Sterling oil and wholesale gas prices

Sources: Bank of England, Bloomberg Finance L.P. and Bank calculations.

(a) Fifteen working day averages to 22 January 2020 and 30 October 2019 respectively.
(b) US dollar forward prices for delivery in 10–25 days’ time converted into sterling.
(c) One‑day forward price of UK natural gas.

Lower water bills are also expected to contribute to the fall in inflation in Q2 as a result of action by the regulator Ofwat. But the reduction in water bills is somewhat less than expected in the November Report, reflecting updated information from Ofwat.

Fuel prices have pushed up the near-term projection, and will add to volatility.

Sterling oil prices have risen by around 7% since the November Report (Chart 2.25). The rise largely reflects reductions in oil production agreed by OPEC and improved demand prospects as global growth has stabilised. The increase in oil prices should feed through to fuel prices such that the near‑term projection for CPI inflation is a little higher than in November. Fuel prices are expected to contribute positively to inflation in Q1, before dragging in Q2 (Chart 2.24). The near‑term projection for inflation is also boosted by recent upside news in import prices, although sterling’s appreciation weighs on them further out.

Looking beyond the near term, labour cost growth is expected to push up inflation…

Wage growth has slowed over the past few months (Section 3), although the decline is small relative to the steady increases seen in recent years. Growth in private sector average weekly earnings (AWE) excluding bonuses was 3.4% in the three months to November, down from a peak of 4% earlier in the year.

The extent to which wages affect companies’ production costs depends on how they are growing relative to productivity. Productivity growth has been very weak and growth is expected to have slowed to below 0% in the four quarters to 2019 Q4 (Chart 4.6). Unit wage cost growth has therefore remained strong, even as wage growth has declined (Chart 2.26), at above its pre‑crisis average rate (Chart 2.27).

Unit wage cost growth is expected to remain robust over the forecast period. While productivity growth is expected to recover somewhat over the forecast period, pushing down on unit wage cost growth, wage growth is expected to remain firm, reflecting the tight labour market (Section 1).

…but so far CPI‑based measures of domestic price pressures have remained relatively low, suggesting that firms have absorbed higher labour costs in their margins.

CPI‑based measures of domestic price pressures, such as core services inflation, have been weaker than expected in recent months, and remain below their pre‑crisis averages (Chart 2.27). These measures were also below the rates consistent with CPI inflation at target in December. Those data, alongside the strength of labour cost growth, could suggest that the profit margins of consumer‑facing companies have been squeezed.

The margins of those companies are difficult to measure directly, but whole‑economy proxies such as the share of profits in GDP have fallen in recent quarters. And reports from the Bank’s Agents also suggest pressure on margins, with some contacts reporting being unable to pass on higher costs to their selling prices in full due to the weaker economy. It is also possible that the rise in labour cost growth has been partly offset by other costs growing more slowly. For example, commercial rent inflation has slowed since 2016, perhaps reflecting the effect of spare capacity in the economy.

Chart 2.26 Unit wage cost growth has risen over 2019

Contributions to four‑quarter private sector unit wage cost growth ^(a)

Sources: ONS and Bank calculations.

(a) Private sector AWE regular pay divided by private sector productivity per head, based on the backcast for the final estimate of private sector output. See Table 4.C in the November 2018 Inflation Report for more details on measures of unit labour costs. Diamond shows Bank staff’s projection for 2019 Q4 based on data to November.

Chart 2.27 Labour cost-based measures of domestic price pressures remain stronger than CPI‑based measures

Four‑quarter growth in measures of domestically generated inflation

Sources: ONS and Bank calculations.

(a) Pre‑crisis averages are the average of four‑quarter growth rates over 1998–2007. Data for private sector regular pay growth is only available from 2000, so the pre-crisis average growth rate is calculated over 2001–07.
(b) Figures for 2018 and 2019 are the four‑quarter growth rates in 2018 Q4 and 2019 Q4 respectively.
(c) 2019 figures for whole‑economy unit labour costs and private sector unit wage costs are Bank staff’s estimates based on data to November.
(d) Whole‑economy total labour costs divided by real GDP, based on the mode of the MPC’s backcast. Total labour costs comprise compensation of employees and the labour share multiplied by mixed income.
(e) See footnote (a) of Chart 2.26.
(f) Core services CPI inflation excludes airfares, package holidays, education and an estimate of the impact of changes in VAT.

Some of the weakness in domestic price pressures could reflect persistent trends in the retail sector…

There have been structural changes in the retail sector that might help to explain subdued price pressures. For example, a rise in e‑commerce may have increased competitiveness, constraining the ability of retailers to raise prices. That trend has been common across advanced economies, so may help to explain muted inflation in the US and the euro area as well.

…but some could reflect cyclical weakness in demand as the economy has slowed.

Subdued domestic price pressures could reflect weak demand growth, which would encourage firms to slow the pace of price rises. As part of its annual assessment of supply, the MPC judged that there had been a slightly greater degree of spare capacity over the past few years than it had previously thought (Section 4), and this has exerted downward pressure on inflation. As demand growth recovers and spare capacity is eroded, inflation is expected to rise towards the target in 2021 (Section 1).

Short-term inflation expectations fell back in Q4…

Measures of households’ expectations for inflation in one and two years’ time fell back in 2019 Q4 (Table 2.C). These measures rose in 2019 Q3, with the Inflation Attitudes Survey suggesting this had been related to Brexit. The dip in Q4 could reflect the unwinding of this effect. Brexit‑related effects, such as the reduced probability of a no‑deal Brexit leading to an appreciation of sterling, may also explain part of the recent fall in short‑term measures of inflation compensation derived from financial market prices.

…while longer-term expectations have been stable on average.

Further out, movements in measures of households’ expectations have been mixed. Expectations five years ahead in the Bank/TNS survey picked up to above their historical average in Q4, but other surveys of households’ longer‑run expectations fell slightly.

Financial market measures, such as five‑year inflation swap rates, five years forward, have been broadly unchanged in the UK over the past year. That is in contrast to the equivalent measures in the US and euro area, which have fallen significantly (Chart 2.28). Measures of UK inflation compensation beyond 10 years have fallen substantially, however. This, combined with a slight pickup at medium‑term horizons over the past year, has led the UK inflation swap curve to become inverted (Chart 2.29). That shape is unusual both historically and when compared to other countries. The fall in long‑term inflation expectations may partly reflect an expected change in the method of calculating RPI inflation. Market intelligence suggests it may also reflect a decline in pension funds’ demand for inflation protection at longer horizons. Since long‑term measures of inflation compensation have fallen internationally, it could also reflect concerns about the outlook for global inflation more generally.

Taken together, the Committee judges that inflation expectations remain well anchored.

Stepping back from recent movements, most measures of inflation expectations in Table 2.C are not markedly different from their historical averages. Taking the evidence from all these measures, the MPC judges that inflation expectations remain well anchored.

Table 2.C Inflation expectations remain well anchored

Measures of inflation expectations ^(a)

Sources: Bank of England, Barclays Capital, Bloomberg Finance L.P., CBI, Citigroup, ONS, TNS, YouGov and Bank calculations.

(a) Data are not seasonally adjusted.
(b) Averages from 2000, or start of series, to 2007. Financial market data start in October 2004, YouGov/Citigroup data start in November 2005 and professional forecasters data start in 2006 Q2.
(c) The household surveys ask about expected changes in prices but do not reference a specific price index. The measures are based on the median estimated price change.
(d) CBI data for the distributive trades sector. Companies are asked about the expected percentage price change over the coming 12 months and the following 12 months in the markets in which they compete.
(e) Instantaneous RPI inflation one and three years ahead and five‑year RPI inflation five years ahead, implied from swaps.
(f) Bank’s survey of external forecasters, CPI inflation rate three years ahead.

Chart 2.28 Implied inflation expectations in the US and euro area have fallen over the past year

Changes in five‑year, five‑year forward inflation compensation ^(a)

Sources: Bloomberg Finance L.P. and Bank calculations.

(a) Derived from swaps. The instruments are linked to the UK RPI, US CPI and euro‑area HICP measures of inflation respectively.

Chart 2.29 The UK inflation swap curve has inverted

Implied expectations of RPI inflation from swaps ^(a)

Sources: Bloomberg Finance L.P. and Bank calculations.

(a) Instantaneous RPI inflation expectations implied by swaps.
(b) January 2020 is an average to 22 January 2020.

Table 2.D Monitoring the near-term outlook ^(a)

Sources: Bank of England, Bloomberg Finance L.P., Department for Business, Energy and Industrial Strategy, Eurostat, IMF World Economic Outlook (WEO), ONS, US Bureau of Economic Analysis and Bank calculations.

(a) Definitions of underlying series are as given in footnotes of Table 1.C in Section 1, unless otherwise stated. Figures show quarterly growth rates unless otherwise stated. All price and wage measures are four‑quarter growth rates.
(b) Data are projections unless otherwise stated.
(c) Projections based on official data to November 2019.
(d) 2019 Q4 data are outturns.
(e) Quarterly level.
(f) Whole-economy regular pay. Growth rates based on KAI7.