The economic outlook
UK GDP growth was modest in 2019 — and is estimated to have been around zero in Q4 — dampened by slower global growth and elevated Brexit-related uncertainties. In its annual reassessment of supply-side conditions, the MPC judged that potential supply growth has also slowed over the past year. On balance, there is judged to be a margin of spare capacity in the economy, which is exerting downward pressure on CPI inflation.
The most recent indicators suggest that global growth has stabilised, reflecting the partial easing of trade tensions and the significant loosening of monetary policy by many central banks over the past year. Global business confidence and other manufacturing indicators have generally picked up. Domestically, near-term uncertainties facing businesses and households have receded. Surveys of business activity have picked up, quite markedly in some cases, and investment intentions appear to have recovered. Housing market indicators have strengthened and consumer confidence has increased slightly.
UK GDP growth is projected to pick up a little in early 2020. Further ahead, and conditioned on a market path for Bank Rate that falls slightly over the forecast period, the recovery in UK growth is supported by a pickup in global activity, a further decline in Brexit uncertainties and the Government’s announced spending measures. Support from these factors is sufficient to boost demand growth above weak potential supply growth. As a result, spare capacity is gradually eroded over the first part of the forecast period and a margin of excess demand builds thereafter. While CPI inflation remains below 2% in the first part of the forecast period, strengthening domestic price pressures alongside a waning drag from energy prices mean that inflation rises towards the target over 2021. Inflation is projected to be 2% in 2022 Q1 and slightly above the target in 2023 Q1.
1.1 Recent developments
UK GDP growth slowed materially in 2019 relative to previous years.
UK GDP is expected to have been flat in 2019 Q4. Over 2019, GDP growth has been volatile owing to Brexit-related factors but, on average, it has slowed relative to previous years (Section 2).
That slowing has been driven partly by weakening global growth…
Slower UK GDP growth partly reflects the impact of global growth, which has weakened significantly to below potential rates. Four-quarter PPP-weighted global growth was 2.8% in 2019 Q3, down from close to 4% at the start of 2018. In UK-weighted terms, global growth has fallen to 1.7% from 3% over the same period. The slowdown, both in the UK and abroad, has been particularly apparent in the manufacturing sector. The weakening in global growth has in part reflected the impact of increased trade protectionism and the associated rise in uncertainty, as well as the past tightening in global financial conditions and domestic weakness in some emerging market economies (EMEs).
…although there are signs that global growth has stabilised.
Quarterly global growth rates have been relatively constant over the recent past. And more timely survey data are consistent with the stabilisation in global growth continuing. For example, PMIs have risen a little since November, including in the manufacturing sector (Chart 1.1). International risky asset prices have also increased. Those developments are likely to have been supported by an easing in trade tensions since November.
Elevated uncertainties about domestic economic policies have also weighed on UK growth.
Uncertainties about the economic outlook, including those related to Brexit, were elevated during 2019. Those uncertainties had an especially large effect on business investment, leading firms to delay spending until they had more clarity about the future trading environment. Business investment growth has been weak since the referendum, and much lower in the UK than in other advanced economies on average over that period (Section 2). Consumer spending has been more resilient to uncertainty. Consumption growth has slowed over the past year, however, and uncertainty may have contributed to weaker housing market activity and discretionary spending on durables.
Uncertainty has declined since November, although it remains elevated by historical standards. For example, the implied volatility from sterling exchange rate options, a key indicator of uncertainty, decreased markedly following the general election in December. In addition, the proportion of firms citing Brexit as one of their top three sources of uncertainty fell to below 45% in the Bank’s DMP Survey in January from 55% in November. Investment intentions had risen sharply according to respondents to the recent manufacturing CBI and Deloitte CFO Surveys, while DMP data pointed to a modest pickup in expected investment growth over the coming year. However, intelligence from the Bank’s Agents suggests that few companies have materially increased their planned investment spending (see Box 2). It is difficult to gauge at this early stage the extent to which companies’ spending intentions have increased as a result of the decline in uncertainty.
Some survey indicators of output have increased recently, which could in part reflect a reduction in uncertainty, as well as potentially signalling a pickup in growth in the near term. The relationship between survey responses and actual GDP growth has tended to be weaker during periods of heightened uncertainty (see Box 3 in the February 2019 Report), with surveys underpredicting growth. While a range of output surveys deteriorated in 2019 Q4, the few surveys which have been taken since the general election have generally picked up. For example, both the output and expectations balances in the flash PMIs picked up significantly in January. The steer from the January CIPS output data alone would be consistent with GDP growth of 0.2% in 2020 Q1 and expectations data would suggest that growth could be stronger still (Chart 1.2). Bank staff expect GDP to grow by 0.2% in 2020 Q1.
Chart 1.1 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 1.2 Most recent surveys of output and expectations point to a pickup in GDP growth in 2020 Q1
Model-based forecasts for quarterly GDP growth in 2020 Q1, based on the latest survey data (a)
Sources: BCC, CBI, IHS Markit/CIPS, ONS and Bank calculations.
(a) Forecasts for GDP growth based on survey indicators of output and expectations. Forecasts use latest values for each survey, assuming those values persist. Q4 surveys for BCC. January surveys for IHS Markit/CIPS. January surveys for CBI used with the prior consent of the CBI.
Wage growth has slowed a little, although labour cost growth has remained robust.
After picking up notably over the past few years, pay growth has fallen back a little in recent months. Private sector regular pay growth was 3.4% in the three months to November, down from a peak of 4.0% earlier in the year. This mainly appears to reflect the effects of some temporary factors unwinding (Section 3). While labour demand might have softened a little, the labour market remains tight, with employment growth robust and the unemployment rate at its lowest for over 40 years. Moreover, productivity growth has fallen over 2019, such that unit labour cost growth has remained robust and above its pre-crisis average rate.
However, CPI inflation has been somewhat subdued.
Consumer price inflation has been subdued, falling below the MPC’s 2% target over 2019. It was 1.4% in 2019 Q4. Although recent moves have largely been due to energy prices, core inflation has also slowed and core services inflation has recently been below the rate estimated to be consistent with inflation at target. The latest data conform to the experience of the past couple of years, in which prices have tended to rise more slowly than unit labour costs.
The MPC judged in its annual assessment of supply that the economy has a margin of spare capacity.
Subdued domestic price pressures are consistent with the economy having a margin of spare capacity. As part of its annual assessment of supply, the MPC judged that there had been a slightly greater degree of slack over the past few years than it had previously thought (Section 4). There is estimated to be around ½% of potential GDP of spare capacity in the economy currently (Table 1.A). That spare capacity lies within companies, with little slack apparent in the labour market.
UK potential supply growth is judged to have weakened, owing in part to the impact of Brexit-related preparations and uncertainty.
While the economy is estimated to have a margin of spare capacity at present, it has not widened as much as the weakening in GDP growth alone would suggest, because potential supply growth is also judged to have slowed. The slowing over the past couple of years partly reflects the influence of Brexit. Brexit-related uncertainty has weighed on investment and hence the amount of capital that companies have to produce output. In addition, while businesses have been preparing for Brexit to help ensure a smooth transition, that planning is likely to have diverted time and effort away from other activities, which may also have weighed on productivity growth (Section 4).
Table 1.A Forecast summary (a)(b)
(a) Modal projections for GDP, CPI inflation, LFS unemployment and excess supply/excess demand. Figures in parentheses show the corresponding projections in the November 2019 Monetary Policy Report. Projections were only available to 2022 Q4 in November.
(b) 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, updated for the announcements made in Spending Round 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 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.
(c) Four-quarter growth in real GDP. The growth rates reported in the table exclude the backcast for GDP. Including the backcast 2020 Q1 growth is 0.4%, 2021 Q1 growth is 1.4%, 2022 Q1 growth is 1.6% and 2023 Q1 growth is 2.0%. This compares to 0.7% in 2020 Q1, 1.7% in 2021 Q1 and 1.9% in 2022 Q1 in the November 2019 Monetary Policy 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.
1.2 The MPC’s projections
The MPC’s projections are conditioned on the assumption that there is an immediate but orderly move to a deep free trade agreement with the EU on 1 January 2021.
Reflecting government policy, the MPC’s projections are conditioned on the UK moving to a deep free trade agreement (FTA) with the EU. The assumptions underpinning the nature of that FTA and its impact on the economy are set out in Box 1 of the November Monetary Policy Report.
On 23 January 2020, the European Union (Withdrawal Agreement) Act 2020 became law. This Act sets out that the Implementation Period ahead of new trading arrangements with the EU taking effect must end on 31 December 2020. Previously, the Government could seek to agree an extension to that period of up to two years. As a result, there was uncertainty about exactly when the UK’s new relationship with the EU would come into effect, and the MPC’s projections smoothed the impact of it coming into force.
In line with the new Act, the MPC’s forecasts now assume that there is an immediate but orderly move to the new trading arrangements on 1 January 2021. As a result, some restrictions on UK-EU trade, particularly customs checks, are assumed to come into place at that point. Those weigh on trade flows to a greater extent over 2021 than was previously expected. Some barriers to trade, such as regulatory divergence, would still emerge only gradually over time. These effects will weigh on productivity growth. Greater trade frictions also add to firms’ costs, which puts a little upwards pressure on inflation.
Uncertainty has declined recently, although it remains elevated.
Indicators of uncertainty have declined since the November Report, broadly as the MPC had expected. Uncertainty remains elevated by historical standards, though. Intelligence from the Bank’s Agents suggests that uncertainty about the near-term outlook has receded. However, uncertainty about the medium term remains heightened. In particular, companies remain unsure about the exact nature of the UK’s future relationship with the EU. The MPC’s projections still assume that uncertainty fades gradually over the forecast period, as more details about the new trading relationship emerge and companies assess how those affect their business.
Political developments have led to an appreciation of sterling.
Over the past few years, UK asset prices — in particular the sterling exchange rate — have been sensitive to political and Brexit developments. Since the November Report, sterling has appreciated by around 1½%. Market contacts suggest that is likely to reflect the reduction in uncertainty about the range of potential outcomes for the Brexit process, especially in the near term. Lower uncertainty over other areas of future government policy may also have played a part. Prices of risky assets have risen too. Over the forecast period, the MPC’s projections are conditioned on sterling remaining broadly flat and the prevailing level of asset prices.
Forward interest rates suggest that monetary policy will remain accommodative.
The MPC’s projections are also conditioned on the market path for interest rates, which in the run-up to the Report averaged close to 0.5% over the forecast period. That accommodative path for monetary policy supports demand.
Announced fiscal policies also provide stimulus to demand.
Demand is also supported by the Government’s announced tax and spending measures. Spending Round 2019 increased planned spending, which was expected to raise GDP by around 0.4% over the forecast period. The Government has announced that Budget 2020 will take place on 11 March.
Global GDP growth
There are signs that global GDP growth has stabilised and it is expected to pick up over the forecast period, supported by policy stimulus.
There are signs in the recent data that global growth has stabilised, albeit at rates a little below potential. Relatively weak growth in the euro area and some EMEs is judged likely to persist in the near term. But world growth is projected to pick up towards potential rates over 2020. That is partly accounted for by a recovery in growth in some EMEs which have been hit by idiosyncratic shocks. The recovery is supported by policy measures, including significant monetary policy easing over 2019 by many central banks. And while trade protectionism continues to weigh on global activity over the forecast period, its effect on growth gradually wanes.
In the central forecast, PPP-weighted world growth picks up from 2¾% in 2019 to 3¼% in 2020, and 3½% in 2021 and 2022. Weighted by UK export shares, world GDP growth is expected to pick up from 1¾% in 2019 to 2% in 2020, and 2¼% in 2021 and 2022 (Table 1.B).
UK GDP growth
In its annual supply stocktake, the MPC judged that UK potential supply growth is likely to remain subdued over the forecast period.
Productivity growth is estimated to have averaged around ½% per year since the financial crisis, relative to around 2¼% beforehand. That has meant that potential supply growth has been very subdued. The MPC judges that productivity growth will pick up a little from current rates over the forecast period. However, it is assumed to remain subdued, given how persistently weak it has been over the past decade.
The evolution of productivity growth is affected by Brexit.
Brexit-related factors are judged to have weighed on productivity growth over the past few years. Over the forecast period, the fall in Brexit-related uncertainty is projected to reduce the drag on investment and therefore productivity growth somewhat. Moreover, the amount of time and effort that companies spend on Brexit planning is no longer expected to act as a drag on growth. However, the rise in trade barriers as the UK leaves the EU is projected to weigh on productivity growth.
Potential supply growth remains subdued over the forecast period (Section 4). Labour supply growth is modest. Productivity growth is weak in the first part of the forecast period. Further out, it picks up somewhat as some of the effects of Brexit-related factors fade. Taken together, potential supply growth averages 1% per year over the forecast period (Table 1.B).
Weak potential supply growth constrains GDP growth.
Weak potential supply growth reduces the pace of GDP growth that is consistent with the MPC meeting its 2% inflation target — it acts as a ‘speed limit’ on the economy. It is assumed to lead to lower demand growth over the forecast period. In part, that is because weak productivity growth reduces the returns that companies will gain by investing. That causes some projects to become unprofitable. Weaker productivity growth also reduces the extent to which companies can increase output and therefore pay. That dampens growth in household incomes and hence spending.
UK demand growth remains subdued in the near term but is projected to pick up gradually as global growth recovers and as the decline in uncertainty boosts spending.
UK demand growth is expected to pick up a little in the near term, but to remain subdued. Thereafter, it increases gradually, driven by the modest recovery in global growth and the waning effects of uncertainty. Those factors drive a recovery in annual business investment growth, which is projected to pick up from close to zero in 2019 to around 3½% by 2022 (Table 1.C). Annual household consumption growth picks up from 1¼% in 2019 to 1¾% in 2021 and 2% in 2022. Those rates of consumption growth are relatively muted compared with history. That partly reflects the dampening effect of weak productivity growth on real income growth. In addition, consumption grows a little more slowly than real labour income over the forecast period. That is similar to developments over the past year, which could suggest that households have been cautious about spending in the face of Brexit-related uncertainty. Government spending continues to boost growth. In contrast, net trade weighs on growth over much of the forecast period. The move to new trading arrangements between the UK and EU weighs on both imports and exports growth.
In the central forecast, four-quarter UK GDP growth picks up from 0.4% in 2020 Q1 to 1.4% in 2021 Q1, 1.6% in 2022 Q1, and 2.0% in 2023 Q1 (Chart 1.3).
Spare capacity is projected to remain in the first part of the forecast period, but as demand growth recovers, slack is eroded and excess demand builds.
Demand growth begins to exceed potential supply growth in mid-2020. Spare capacity persists over 2020 but is eroded gradually. Thereafter, excess demand emerges and builds to around ¾% of potential GDP by the end of the forecast period (Table 1.A). The unemployment rate is projected to be broadly stable in the near term, and then falls to 3.5% by the end of the forecast period, a little further below its equilibrium rate (Chart 1.4). Spare capacity within firms is eroded.
Table 1.B Potential supply growth has slowed and is expected to remain subdued
Decomposition of estimated potential supply growth (a)
Sources: ONS and Bank calculations.
(a) Average percentage point contributions to annual growth unless otherwise specified. Contributions may not sum to the total due to rounding.
(b) Positive numbers indicate that a fall in the equilibrium unemployment rate has increased potential labour supply.
(c) Based on a growth-accounting framework using a constant returns to scale Cobb-Douglas production function, with total output to capital elasticity of ⅓.
(d) Capital deepening refers to growth in capital services per person-hour.
(e) Total factor productivity growth refers to improvements in the efficiency with which both capital and labour are used to produce output. Calculated as a residual.
Chart 1.3 GDP projection based on market interest rate expectations, other policy measures as announced
The fan chart depicts the probability of various outcomes for GDP growth. It has been conditioned on the assumptions in Table 1.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. 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.
CPI inflation is projected to remain below 2% throughout 2020, partly reflecting the impact of lower utility bills, as well as the influence of slack.
Over the coming quarters, inflation will be affected by developments in a number of regulated prices. Changes to Ofgem’s energy price cap introduce some volatility — with CPI inflation expected to pick up to 1.8% in 2020 Q1, before falling back to around 1¼% in the middle of the year. The expected reduction in water bills as a result of action by the regulator Ofwat is also expected to contribute to the fall in inflation in 2020 Q2. Inflation is expected to remain materially below 2% over the second half of 2020 as those factors, as well as spare capacity, continue to drag.
As the drag from lower utilities prices fades and domestic price pressures strengthen in response to the erosion of spare capacity, CPI inflation returns to the target.
CPI inflation begins to rise towards the 2% target in late 2020 as the temporary negative contributions from energy and utility prices start to unwind. Domestic price pressures also rise as spare capacity is used up and excess demand then emerges. Wage growth is projected to pick up over the second half of the forecast period, supported by low unemployment. While productivity growth increases as well, unit labour cost growth remains firm. Those cost pressures are passed through to CPI inflation. As a result, inflation is projected to be 2.0% in 2022 Q1 and 2.1% in 2023 Q1 (Chart 1.5).
Relative to the November forecast, growth slowed more than expected in 2019 Q4 and there is judged to be more spare capacity in the economy at present.
Following its annual reassessment of the supply side of the economy, the MPC judged that the current degree of spare capacity is somewhat greater than it had previously thought. In part, that is because of weaker-than-expected GDP growth in 2019 Q4. In addition, subdued CPI inflation is judged to signal that the margin of spare capacity in the economy has been slightly greater over the past.
Over the forecast period, both supply and demand growth are projected to be weaker.
The MPC has also revised down its assessment of potential supply growth over the forecast period as part of its annual stocktake. In part, that reflects the weakness of productivity growth over the past year, which extends the pattern seen since the financial crisis. Productivity growth is also dampened by the effect of trade barriers with the EU coming into effect more immediately than in November.
Chart 1.4 Unemployment projection based on market interest rate expectations, other policy measures as announced
The fan chart depicts the probability of various outcomes for LFS unemployment. It has been conditioned on the assumptions in Table 1.A footnote (b). The coloured bands have the same interpretation as in Chart 1.3, 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 Q4, a quarter earlier than the fan for CPI inflation. That is because Q4 is a staff projection for the unemployment rate, based in part on data for October and November. The unemployment rate was 3.8% in the three months to November, and is projected to be 3.8% in Q4 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 1.5 CPI inflation projection based on market interest rate expectations, other policy measures as announced
Chart 1.5 depicts the probability of various outcomes for CPI inflation in the future. It has been conditioned on the assumptions in Table 1.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 chart is 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.
Weaker potential supply growth is assumed to lead to lower demand growth over the forecast period. In addition, demand growth is judged likely to recover a little more gradually in the second part of the forecast period, such that excess demand builds to a somewhat smaller degree. Taken together, GDP is projected to be ¾% lower over the forecast period than it was in November.
The MPC’s projection for CPI inflation over the next three years is slightly lower than in November.
The somewhat greater extent and persistence of spare capacity, and the smaller margin of excess demand that builds over the forecast period relative to November, lowers the projection for CPI inflation slightly. The appreciation of sterling also weighs on inflation a little. Partially offsetting those effects is slightly greater upwards pressure from the more immediate introduction of trade barriers.
At its meeting ending on 29 January 2020, 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 will be set to ensure a sustainable return of inflation to the 2% target. Policy may need to reinforce the expected recovery in UK GDP growth should the more positive signals from recent indicators of global and domestic activity not be sustained or should indicators of domestic prices remain relatively weak. Further ahead, if the economy recovers broadly in line with the MPC’s projections, some modest tightening of policy may be needed to maintain inflation sustainably at the target.
1.3 Key judgements and risks
Key Judgement 1
Global GDP growth is projected to rise towards potential rates.
The projected pickup in world growth depends in part on growth recovering in EMEs…
The MPC’s projections for global growth to rise are driven in part by a pickup in EME growth. In turn, that partly reflects the recovery of some economies from recent downturns. Growth in many EMEs is supported by looser financial conditions — partly reflecting easier domestic monetary policy as well as lower US interest rates, which have boosted some EME risky asset prices. Activity in advanced economies is also buoyed by supportive financial conditions and monetary policy stimulus gaining traction. Policy stimulus could boost growth by more than expected. There is a risk, however, that the interest rate required to boost demand and return inflation sustainably to target rates has declined somewhat, given headwinds to growth from heightened global uncertainty, for example. That could reduce the amount of stimulus that recent policy actions will provide.
…as well as the impact of protectionist trade policies fading.
The projected recovery in global growth also reflects a fading impact from trade protectionism — although it continues to dampen the level of activity overall. The extent to which trade protectionism dampens activity depends on both its direct effects through trade flows, supply chains and production costs, and its indirect effects on uncertainty, business sentiment and investment (see Section 3 of the November Report). Since November, there has been some positive trade policy news. In particular, the US and China have agreed the first phase of a trade deal which reduces some tariff rates relative to what was previously expected. That reduces the size of the assumed direct effects relative to November, though only marginally, so they continue to subtract around 0.3% from PPP-weighted GDP. The indirect effects are assumed to be unchanged, at around 0.7% of PPP-weighted GDP.
The projections assume that no further trade barriers are announced. If any are, they would weigh on global growth. However, the projections also assume that policy uncertainty remains high. If it declines, growth might recover more sharply. The increase in international risky asset prices over the past few months might suggest that there is somewhat more confidence about the outlook for trade policy. But concerns about other global risks — including the outbreak of a new strain of coronavirus — might have risen.
Taken together, the MPC judges that the risks around the global growth projection are broadly balanced.
Key Judgement 2
Supply growth has been weak, partly owing to the impact of Brexit, and remains subdued over the forecast period.
The weakness of productivity growth since the financial crisis is assumed to persist to some extent.
Productivity growth is projected to be subdued relative to pre-crisis rates, although it picks up over the forecast period. The improvement in productivity growth partly reflects an assumed increase in the efficiency with which capital and labour are used to produce output — total factor productivity (TFP). It is possible that research and development expenditure — which has been found to be a key driver of innovation (Section 4) and has been relatively resilient in recent years — could support a stronger rise in TFP growth. However, productivity growth has consistently been lower than expected over the past decade or so, and may fail to pick up again.
The projection for productivity growth will be sensitive to the impact of Brexit-related factors…
Over the forecast period, companies are judged to be unlikely to increase further the time and effort they spend on Brexit planning per year, so that ceases to act as a drag on productivity growth. There are risks around that judgement, however. It is possible, for example, that companies consider it necessary to step up their Brexit planning, particularly around the time of significant changes in trading arrangements. That would drag on productivity growth. It is also possible, especially further out in the forecast, that firms are able to cut back the amount of resources they spend on Brexit planning. That could temporarily boost productivity growth relative to the MPC’s projections.
…including the rise in trade barriers as the UK leaves the EU.
The outlook for productivity growth will also be significantly affected by the nature and impact of the UK’s new trading relationship with the EU. Until the details of the FTA are finalised, there will be uncertainty about the exact barriers to trade that will arise. It is also difficult to estimate the effect of those barriers on trade flows. While the MPC has modelled their impact based on past empirical relationships (see Box 1 in the November Report), there are very few historical examples of trading relationships becoming less aligned. The impact of increasing barriers to trade has been assumed to be symmetric to reducing them. However, the impact of increasing trade barriers might be smaller than estimates of removing them as the trading relationships between UK and EU companies are already well established. Alternatively, the impact of a large, advanced and open economy like the UK leaving the EU might be bigger than the average estimated impact across a wide range of countries.
The MPC judges that the risks around its projections for potential supply growth are broadly balanced.
Key Judgement 3
The assumed recovery in global growth and reduction in Brexit-related uncertainty boost UK spending, such that demand growth outstrips supply growth.
The strength of the pickup in GDP growth will depend importantly on how uncertainty evolves and on how households, businesses and financial markets respond.
Over the past few months, uncertainty appears to have fallen broadly as the MPC had anticipated. The forecasts are conditioned on the assumption that uncertainty will continue to decline gradually over the forecast period.
It is possible that elevated uncertainty persists for longer than anticipated if it takes time for more clarity about the exact nature of the UK’s future relationship with the EU to emerge, or for companies to assess the implications for their business models. That would weigh on consumption and, particularly, investment growth. However, if companies re-start a large number of previously paused projects in response to the recent reduction in short-term uncertainty, investment could rebound more quickly. Similarly, household spending growth could pick up by more than projected if uncertainty has been a material constraint up to now. Some indicators of house prices have picked up sharply over the past few months, which might be consistent with a waning drag from uncertainty. The response of spending to news about the nature of the UK’s withdrawal from the EU will also be affected by any associated changes in the sterling exchange rate and asset prices.
The MPC judges that the risks around its projections for demand growth are broadly balanced.
Key Judgement 4
While CPI inflation remains below 2% in the first part of the forecast period, it returns to the target as the drag from energy prices wanes and domestic price pressures build.
Developments in CPI inflation will be sensitive to the degree of spare capacity in the economy, which the MPC judges to currently be modest.
There is uncertainty about the current degree of spare capacity in the economy, with different indicators pointing in different directions. On the one hand, price-based measures of domestically generated inflation have been subdued, perhaps suggesting a material margin of excess supply. On the other hand, the unemployment rate has been below its estimated equilibrium and labour cost growth has been robust, which is more consistent with there being excess demand in the economy.
The outlook will also depend on how firm unit labour cost growth remains…
After remaining broadly stable in the near term, unemployment falls further over the forecast period, putting upward pressure on wage growth. As a result, unit labour cost growth is projected to remain firm, even as productivity growth picks up. There is a risk that the recent softening in wage growth indicates that underlying pay pressures are less strong than in the MPC’s projections, which could also be consistent with a lower equilibrium unemployment rate. Alternatively, if pay growth is maintained without a pickup in productivity growth, unit labour cost growth could be stronger.
…and the extent to which those cost pressures eventually feed through to CPI inflation.
Firm labour cost growth is assumed to push up inflation over the forecast period, consistent with the recent squeeze in consumer-facing companies’ profit margins coming to an end. There is a risk that consumer-facing companies continue to absorb some of the higher labour cost pressures in their profit margins so domestic price pressures remain subdued. Or that other costs fall and offset the impact of higher labour costs on margins. Alternatively, margins could be rebuilt to a greater extent as excess demand emerges.
The risks around the MPC’s projection for inflation 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 (Chart 1.6). It still recovers to outstrip the subdued rate of potential supply growth, however, such that excess demand builds from the end of 2021. CPI inflation rises from the end of this year, and reaches 2.0% at the end of 2022 (Chart 1.7).
Chart 1.6 GDP projection based on constant nominal interest rates at 0.75%, other policy measures as announced
See footnote to Chart 1.3.
Chart 1.7 CPI inflation projection based on constant nominal interest rates at 0.75%, other policy measures as announced
See footnote to Chart 1.5.
Table 1.C Indicative projections consistent with the MPC’s forecast (a)(b)
Sources: Bank of England, Bloomberg Finance L.P., Department for Business, Energy and Industrial Strategy, Eurostat, IMF World Economic Outlook (WEO), National Bureau of Statistics of China, ONS, US Bureau of Economic Analysis and Bank calculations.
(a) The profiles in this table should be viewed as broadly consistent with the MPC’s projections for GDP growth, CPI inflation and unemployment (as presented in the fan charts).
(b) Figures show annual average growth rates unless otherwise stated. Figures in parentheses show the corresponding projection in the November 2019 Monetary Policy Report. Calculations for back data based on ONS data are shown using ONS series identifiers.
(c) Chained-volume measure. Constructed using real GDP growth rates of 188 countries weighted according to their shares in UK exports.
(d) Chained-volume measure. Constructed using real GDP growth rates of 189 countries weighted according to their shares in world GDP using the IMF’s purchasing power parity (PPP) weights.
(e) Chained-volume measure.
(f) Chained-volume measure.
(g) Chained-volume measure. Constructed using real GDP growth rates of 155 EME countries, as defined by the IMF WEO, weighted according to their relative shares in world GDP using the IMF’s PPP weights.
(h) Chained-volume measure.
(i) Excludes the backcast for GDP.
(j) Chained-volume measure. Includes non-profit institutions serving households. Based on ABJR+HAYO.
(k) Chained-volume measure. Based on GAN8.
(l) Chained-volume measure. Whole-economy measure. Includes new dwellings, improvements and spending on services associated with the sale and purchase of property. Based on DFEG+L635+L637.
(m) Chained-volume measure. The historical data exclude the impact of missing trader intra‑community (MTIC) fraud. Since 1998 based on IKBK-OFNN/(BOKH/BQKO). Prior to 1998 based on IKBK.
(n) Chained-volume measure. The historical data exclude the impact of MTIC fraud. Since 1998 based on IKBL-OFNN/(BOKH/BQKO). Prior to 1998 based on IKBL.
(o) Chained-volume measure. Exports less imports. GDP data based on the mode of the MPC’s GDP backcast.
(p) Wages and salaries plus mixed income and general government benefits less income taxes and employees’ National Insurance contributions, deflated by the consumer expenditure deflator. Based on [ROYJ+ROYH-(RPHS+AIIV-CUCT)+GZVX]/[(ABJQ+HAYE)/(ABJR+HAYO)].
(q) Annual average. Percentage of total available household resources. Based on NRJS.
(r) 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.
(s) Annual average. Per cent of potential GDP. A negative figure implies output is below potential and a positive figure that it is above.
(t) GDP per hour worked. GDP data based on the mode of the MPC’s GDP backcast. Hours worked based on YBUS.
(u) Four-quarter growth in LFS employment in Q4. Based on MGRZ.
(v) Level in Q4. Average weekly hours worked, in main job and second job. Based on YBUS/MGRZ.
(w) LFS unemployment rate in Q4. Based on MGSX.
(x) Level in Q4. Percentage of the 16+ population. Based on MGWG.
(y) Four-quarter inflation rate in Q4.
(z) Four-quarter inflation rate in Q4 excluding fuel and the impact of MTIC fraud.
(aa) Contribution of fuels and lubricants and gas and electricity prices to four-quarter CPI inflation in Q4.
(ab) Four-quarter growth in whole-economy total pay in Q4. Growth rate since 2001 based on KAB9. Prior to 2001, growth rates are based on historical estimates of AWE, with ONS series identifier M09M.
(ac) 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.
(ad) 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.
Box 1 Monetary policy since the November Report
At its meeting ending on 18 December 2019, the MPC judged that the existing stance of monetary policy was appropriate.
Since the MPC’s November meeting, economic data had been broadly in line with the November Report. Global growth had shown tentative signs of stabilising and global financial conditions remained supportive. The partial de-escalation of the US-China trade war provided some additional support to the outlook relative to the November Report, although trade tensions remained elevated.
UK GDP had increased by 0.3% in 2019 Q3 and was expected to rise only marginally in Q4. Household consumption had continued to grow steadily, but business investment and export orders had remained weak.
Financial markets had remained sensitive to domestic policy developments. Since the November Report, the sterling exchange rate had appreciated by 2% and UK-focused equities had outperformed their international counterparts. The expected path for Bank Rate in three years’ time was around 10 basis points higher than the 15-day average on which the November Report projections had been conditioned. These movements probably reflected a perceived reduction in tail risks around the Brexit process as well as an updated judgement among market participants about the likely central outcome. Sterling implied volatilities had fallen back materially, including relative to implied volatilities in other currencies. There was no evidence yet about the extent to which policy uncertainties among companies and households had declined.
There continued to be some signs that the labour market was loosening, although it remained tight. Employment growth had slowed and vacancies had fallen, but the unemployment rate had remained stable and the employment rate was around its record high. Despite the stability of the unemployment rate, a small margin of excess supply had nevertheless appeared to open up in the wider economy. That slack was judged to lie mainly within companies, consistent with weakness in some survey measures of capacity utilisation and reflecting the assumption that there had been little deterioration in potential productivity growth relative to recent years.
Although pay growth had eased somewhat, this appeared to have reflected primarily the unwind of a previous temporary boost. Regular annual AWE growth was around 3½% compared with around 4% during the middle of the year. Unit labour costs had nevertheless continued to grow at rates above those consistent with meeting the inflation target in the medium term.
Headline and core CPI inflation had both been unchanged in November, at 1.5% and 1.7% respectively, broadly as expected in the November Report. The headline rate was still expected to fall to around 1¼% by the spring, owing to the temporary effects of falls in regulated energy and water prices. Excluding rents, core services CPI inflation had remained at rates consistent with meeting the inflation target in the medium term, although that measure had fallen back in November. The Committee judged that inflation expectations remained well anchored.
The MPC noted that if global growth failed to stabilise or if Brexit uncertainties remained entrenched, monetary policy may need to reinforce the expected recovery in UK GDP growth and inflation. Further ahead, provided these risks do not materialise and the economy recovers broadly in line with the MPC’s latest projections, some modest tightening of policy, at a gradual pace and to a limited extent, may be needed to maintain inflation sustainably at the target.
The 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.
The 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.