Monetary Policy Summary

The Bank of England’s Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment. At its meeting ending on 2 November 2022, the MPC voted by a majority of 7–2 to increase Bank Rate by 0.75 percentage points, to 3%. One member preferred to increase Bank Rate by 0.5 percentage points, to 2.75%, and one member preferred to increase Bank Rate by 0.25 percentage points, to 2.5%.

As set out in the accompanying November Monetary Policy Report, the MPC’s updated projections for activity and inflation describe a very challenging outlook for the UK economy.

Since the MPC’s previous forecast, there have been significant developments in fiscal policy. Uncertainty around the outlook for UK retail energy prices has fallen to some extent following further government interventions. For the current November forecast, and consistent with the Government’s announcements on 17 October, the MPC’s working assumption is that some fiscal support continues beyond the current six-month period of the Energy Price Guarantee (EPG), generating a stylised path for household energy prices over the next two years. Such support would mechanically limit further increases in the energy component of CPI inflation significantly, and reduce its volatility. However, in boosting aggregate private demand relative to the August projections, the support could augment inflationary pressures in non-energy goods and services.

Other fiscal measures announced up to and including 17 October also support demand relative to the August projection. The MPC’s forecast does not incorporate any further measures that may be announced in the Autumn Statement scheduled for 17 November.

There have been large moves in UK asset prices since the August Report. These partly reflect global developments, although UK-specific factors have played a very significant role during this period. The MPC’s projections are conditioned on the path of Bank Rate implied by financial markets in the seven working days leading up to 25 October. That path rose to a peak of around 5¼% in 2023 Q3, before falling back. Overall, the path is around 2¼ percentage points higher over the next three years than in the August projection. The higher market yield curve has pushed new mortgage rates up sharply. Financial conditions have tightened materially, pushing down on activity over the forecast period.

GDP is expected to decline by around ¾% during 2022 H2, in part reflecting the squeeze on real incomes from higher global energy and tradable goods prices. The fall in activity around the end of this year is expected to be less marked than in August, however, reflecting support from the EPG. The labour market remains tight, although there are signs that labour demand has begun to ease.

CPI inflation was 10.1% in September and is projected to pick up to around 11% in 2022 Q4, lower than was expected in August, reflecting the impact of the EPG. Services CPI inflation has risen. Nominal annual private sector regular pay growth rose to 6.2% in the three months to August, 0.6 percentage points higher than expected in the August Report.

In the MPC’s November central projection that is conditioned on the elevated path of market interest rates, GDP is projected to continue to fall throughout 2023 and 2024 H1, as high energy prices and materially tighter financial conditions weigh on spending. Four-quarter GDP growth picks up to around ¾% by the end of the projection. Although there is judged to be a significant margin of excess demand currently, continued weakness in spending is likely to lead to an increasing amount of economic slack emerging from the first half of next year, including a rising jobless rate. The LFS unemployment rate is expected to rise to just under 6½% by the end of the forecast period and aggregate slack increases to 3% of potential GDP.

In the MPC’s central projection, CPI inflation starts to fall back from early next year as previous increases in energy prices drop out of the annual comparison. Domestic inflationary pressures remain strong in coming quarters and then subside. CPI inflation is projected to fall sharply to some way below the 2% target in two years’ time, and further below the target in three years’ time.

In projections conditioned on the alternative assumption of constant interest rates at 3%, activity is stronger than in the MPC’s forecast conditioned on market rates, although GDP is still expected to be falling at the end of 2023. CPI inflation is projected to be a little above the target at the end of the second year. However, it falls more than a percentage point below the target at the end of the third year.

The risks around both sets of inflation projections are judged to be skewed to the upside in the medium term, however, in part reflecting the possibility of more persistence in wage and price setting.

The MPC’s remit is clear that the inflation target applies at all times, reflecting the primacy of price stability in the UK monetary policy framework. The framework recognises that there will be occasions when inflation will depart from the target as a result of shocks and disturbances. The economy has been subject to a succession of very large shocks. Monetary policy will ensure that, as the adjustment to these shocks continues, CPI inflation will return to the 2% target sustainably in the medium term. Monetary policy is also acting to ensure that longer-term inflation expectations are anchored at the 2% target.

The labour market remains tight and there have been continuing signs of firmer inflation in domestic prices and wages that could indicate greater persistence. Currently announced fiscal policy, including the MPC’s working assumption about continued fiscal support for household energy prices, will also support demand, relative to the Committee’s projections in August. The Committee will take account of any additional information in the Government’s Autumn Statement at its December meeting and in its next forecast in February.

In view of these considerations, the Committee has voted to increase Bank Rate by 0.75 percentage points, to 3%, at this meeting.

The majority of the Committee judges that, should the economy evolve broadly in line with the latest Monetary Policy Report projections, further increases in Bank Rate may be required for a sustainable return of inflation to target, albeit to a peak lower than priced into financial markets.

There are, however, considerable uncertainties around the outlook. The Committee continues to judge that, if the outlook suggests more persistent inflationary pressures, it will respond forcefully, as necessary.

The MPC will take the actions necessary to return inflation to the 2% target sustainably in the medium term, in line with its remit. The Committee will, as always, consider and decide the appropriate level of Bank Rate at each meeting.

1: The economic outlook

1.1: The conditioning assumptions underlying the MPC’s projections

For this forecast, the MPC has made three adjustments to the conditioning assumptions underlying its projections.

First, in light of events at the start of the standard 15‑working day conditioning path window between 5 and 25 October, the MPC has decided on this occasion to base its projections on an average of UK asset and commodity prices calculated over the final seven days of the 15‑day period. Other non-UK asset and commodity prices continue to be based on a 15‑day window. The Committee intends to revert to its usual 15-day window for all asset prices in future Reports.

Second, the Committee’s projections are usually conditioned on announced fiscal policy. This forecast incorporates the announcements made by the Chancellor of the Exchequer up to and including 17 October, and, consistent with that, includes a working assumption about continued fiscal support for household energy bills, generating a stylised path for household energy prices over the first two years of the forecast period (Box A). The MPC’s forecast does not incorporate any further measures that may be announced at the Autumn Statement scheduled for 17 November. The Committee intends to condition its next forecast in February 2023 on announced fiscal policy.

Third, beyond the first two years of the forecast period, UK household energy prices are assumed to follow a path consistent with their respective downward-sloping wholesale futures curves. This is a change to the Committee’s recent convention that wholesale energy prices follow their respective futures curves for the first six months of the projection only and then remain constant. Given the two years of fiscal support assumed by the Committee, using that previous convention would imply a path for household energy bills beyond that point that would lead to a purely mechanical jump in the CPI inflation projection.

Reflecting this same change in convention, wholesale energy prices are assumed to follow their respective futures curves over the whole forecast period, rather than for the first six months of the projection only and then remaining constant as assumed previously. Although spot prices have fallen materially, medium-term wholesale gas futures prices have almost doubled again since August (Chart 3.1), reflecting Russia’s restriction of gas supplies to Europe and concerns about the sufficiency of gas storage beyond this winter. In contrast, weaker global demand has weighed on the prices of some other commodities, including oil. Significant uncertainty remains around the outlook for wholesale energy prices, and a persistently higher path remains a possible alternative scenario. The Committee will keep its wholesale energy price conditioning assumption under review.

Otherwise, the projections are conditioned on:

• The paths for policy rates implied by financial markets. Since the August Report, the rise in the market yield curve in the United Kingdom has been larger than in the United States and in the euro area (Chart 2.7). In the UK, the market-implied path for Bank Rate was consistent with Bank Rate rising to a peak of around 5¼% in 2023 Q3, before falling back. Overall, the path is around 2¼ percentage points higher on average over the next three years than in the August projection (Table 1.B). The path for Bank Rate implied by the latest Market Participants Survey is lower than the market curve, as it was in August.
• A path for the sterling effective exchange rate index that is around 2% lower than in August, and is declining gradually over the forecast period given the 50% weight in the Committee’s conditioning assumption for expected interest rate differentials (Table 1.B and Chart 2.10).

1.2: Key judgements and risks

Key judgement 1: there has been a material tightening in financial conditions, including the elevated path of market interest rates. In addition, high energy prices continue to weigh on spending, despite an assumption of some fiscal support for household energy bills over the next two years. As a result, the UK economy is expected to remain in recession throughout 2023 and 2024 H1, and GDP is expected to recover only gradually thereafter.

Following growth of 0.2% in the second quarter, UK GDP is expected to have contracted by 0.5% in 2022 Q3, and is projected to fall by 0.3% in Q4 (Section 2.3). Underlying output, defined as market sector output adjusted for the estimated effects of the recent additional bank holidays, is expected to decline by around ½% in both quarters (Chart 2.14). This projection is consistent with recent business surveys of activity, including the S&P Global/CIPS UK PMI, which have weakened significantly over recent months, and have moved down closer into line with already very weak indicators of consumer confidence. The weakness in GDP partly reflects the squeeze on real incomes from higher global energy and tradable goods prices. The fall in activity around the end of this year is expected to be less marked than in the August Report, however, reflecting support from the Government’s EPG for households (Box A).

Box A also sets out the Committee’s working assumption about continued fiscal support, consistent with the Government’s announcements on 17 October, which generates a stylised path for household energy prices over the first two years of the forecast period. This boosts activity materially relative to the August Report projection that did not assume any fiscal support over this period and was conditioned on the MPC’s previous assumption that wholesale energy prices would remain constant at very elevated levels. Nevertheless, the hit to household incomes from energy prices remains significant.

Bank staff have re-examined the treatment of energy in the MPC’s forecast (Box B). As a result and consistent with most empirical studies, the MPC’s projections now explicitly incorporate some substitution between the demand for energy and other goods, with companies assumed to be able to substitute away from energy to a greater extent than households. This change in treatment reduces the sensitivity of aggregate demand to energy price changes and, taking account of all the developments in retail energy prices since the onset of the energy crisis, boosts GDP over the forecast period relative to the August Report projections.

In addition to energy support policies, the other fiscal measures announced up to and including 17 October support demand relative to the August projection (Box A). The MPC’s forecast does not incorporate any further measures that may be announced at the Autumn Statement scheduled for 17 November.

There have been large moves in UK asset prices since the August Report (Section 2.2). These partly reflect global developments, although UK-specific factors played a very significant role during that period. Short and longer-term government bond yields have picked up substantially, risky asset prices have fallen and the sterling effective exchange rate index has depreciated by around 2%.

In large part reflecting a rapid response by lenders to developments in risk-free interest rates, advertised rates on new mortgages have increased sharply, while the number of available mortgage products has fallen back (Section 2.2). Around a quarter of the outstanding stock of mortgages are scheduled to reach the end of their fixed-rate term between 2022 Q4 and the end of 2023, raising mortgage costs significantly for these households. The cost of borrowing for UK firms has also picked up since August, and the availability of bank credit has fallen for SMEs.

The Committee’s central projection incorporates a tightening in credit conditions. However, the sharp tightening in mortgage availability seen during late September is not assumed to persist over the forecast period, consistent with the latest supervisory intelligence. Reference rates have fallen back from their highs in late September, and there have been moderate falls in some mortgage rates in the days leading up to the MPC’s November meeting.

Taken together, financial conditions have tightened materially recently, pushing down on activity over the forecast period.

GDP is projected to continue to fall throughout 2023 and 2024 H1, as high energy prices and materially tighter financial conditions weigh on spending. In the Committee’s central projection, calendar-year GDP growth is -1½% in 2023 and -1% in 2024 (Table 1.D). Four-quarter GDP growth picks up to around ¾% by the end of the projection (Chart 1.1), although GDP growth is expected to remain well below pre-pandemic rates.

In projections conditioned on the alternative assumption of constant interest rates at 3%, activity is stronger than in the MPC’s forecast conditioned on market rates. GDP is still expected to be falling at the end of 2023, however, and activity remains very weak in 2024.

Compared with previous UK recessions of similar scales, GDP remains weak relative to its pre-recession level for a prolonged period in the MPC’s latest forecast, although the depth of the recession is much shallower for the projection conditioned on constant interest rates (Chart 1.2).

Chart 1.1: GDP growth projection based on market interest rate expectations, other policy measures as announced

Footnotes

• The fan chart depicts the probability of various outcomes for GDP growth. It has been conditioned on the assumptions in Section 1.1. To the left of the shaded area, the distribution reflects uncertainty around revisions to the data over the past. To the right of the shaded area, 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 aqua 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 aqua area of the fan chart. Over the forecast period, this has been depicted by the 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.

Chart 1.2: Changes in GDP since pre-recession peak in past recessions and the MPC's November 2022 projections ^(a)

Footnotes

• Sources: ONS and Bank calculations.
• (a) Recessions are defined as at least two consecutive quarters of negative GDP growth. Past recessions shown began in 1980 Q1, 1990 Q3 and 2008 Q2. The MPC's projections start in 2022 Q3.

Real post-tax household income is projected to fall by ¼% in this calendar year and by -1½% in 2023 (Table 1.D), despite the additional support from the EPG. Thereafter, it is projected to recover by ¾% in 2024 and by 1% in 2025.

Aggregate household saving has remained elevated relative to the pre-pandemic period, and to a greater degree following recent ONS Blue Book revisions. The Committee judges that the saving ratio is likely to rise during the forecast period, from around 7½% to 9%. In part, this reflects precautionary saving behaviour by households, broadly consistent with the rising path of unemployment (Key judgement 2). Calendar-year household spending is expected to fall by 1% in 2023 and by ½% in 2024 (Table 1.D). Housing investment is expected to fall sharply in 2023 and 2024 (Table 1.D), consistent with its tendency to make a disproportionately large contribution to overall GDP growth at turning points in the economic cycle.

Business investment is expected to be very subdued in the near term, consistent with elevated levels of financial market volatility, real-economy indicators of uncertainty (Section 2.3) and the latest intelligence from the Bank’s Agents. Thereafter, investment continues to decline, reflecting the weakness in overall demand and the rising path for Bank Rate in the MPC’s conditioning assumption. Business investment is expected to fall by 3½% in 2023 and by 6½% in 2024 (Table 1.D).

The weakness in UK demand growth over the projection also reflects the slowing in the world economy, although the global activity outlook is broadly unchanged compared with August. Since the previous Report, other European governments have announced a range of policy measures to address the impact of high energy prices for households and businesses, which is supporting the euro-area growth outlook. Tighter financial conditions and a slowing housing market are expected to weigh on growth in the US, however. In China, weakness in the property market is also expected to continue to depress growth, while the Chinese authorities’ zero-Covid policy could continue to constrain activity. In the MPC’s central projection, annual UK-weighted world GDP growth is projected to slow from 2¾% in 2022, to 1% in 2023, before rising thereafter but at below pre-pandemic rates (Table 1.D).

The risks around the projection for GDP growth are judged to be balanced.

The extent to which higher energy bills and mortgage rates affect aggregate consumption will depend on how households respond. There are risks in both directions around the central projection for household spending and hence GDP. Spending could be stronger than expected if some households run down their savings to a greater extent than projected. In particular, higher-income households are likely to be less affected by the energy price shock and to have the highest savings. These households were more likely to be maintaining, or even increasing, spending volumes according to the latest Bank/NMG survey (Chart 2.19). Consumption could also be stronger than expected if the labour market is more resilient in the near term. As set out in the Annex of this Report, external forecasters’ projections for activity are stronger than the MPC’s throughout the forecast period.

Demand could weaken by more than expected if households build up their saving relative to their incomes to a greater extent. While aggregate saving data are elevated relative to the pre-pandemic period, responses to the Bank/NMG survey suggest that many households no longer have additional savings due to the pandemic. In addition, recent economic developments could increase households’ uncertainty about the future, leading them to increase their precautionary saving by more than expected and lower their spending further.

There are also particular uncertainties around the impact on consumption of recent and prospective developments in the mortgage market. To the downside for growth, there is a risk of a more material or persistent tightening in household credit conditions. Based on evidence from previous cycles and in the face of significantly higher mortgage payments, some households may choose to cut back their consumption further to avoid building up significant mortgage arrears. Working in the other direction, the structure of the mortgage and housing markets has changed materially over recent decades such that a smaller proportion of mortgagors have a floating-rate mortgage, delaying the pass-through of higher mortgage rates to some extent relative to previous cycles. In addition, a somewhat smaller proportion of households have a mortgage and some homeowners may be able to borrow against their housing wealth, which has risen significantly over recent years.

Key judgement 2: although there is judged to be a greater margin of excess demand currently, continued weakness in spending leads to an increasing degree of economic slack emerging from 2023 H1, including a rising unemployment rate.

Most indicators suggest that there is currently a significant margin of excess demand across the economy as a whole, and to a greater degree than was judged at the time of the August Report (Table 1.A), in part reflecting the implications of the change in the treatment of energy in the MPC’s forecast (Box B).

The labour market has also remained tight, with an unemployment rate of 3.5% in the three months to August (Section 2.4), its lowest level since 1974. That is below the MPC’s assessment of the long-term equilibrium rate of unemployment of just above 4%. Although there are signs that labour demand is starting to soften, the vacancy to unemployment ratio, a measure of labour market tightness, remains extremely elevated.

A key reason why the labour market has tightened since the pandemic is because of a marked increase in the number of people inactive in the labour market (Section 2.4). The rise in inactivity has been concentrated among people aged 50 to 64, and partly reflects those people leaving the labour force due to long-term sickness. In contrast to some downside news earlier this year, recent aggregate inactivity is higher than expected in the August Report.

Companies are still expected to respond initially to continued weakness in demand by using their existing inputs less intensively. So, the labour market is expected to remain relatively tight over the next few quarters. This is consistent with the Agents’ latest intelligence that many companies are reluctant actively to reduce headcount unless they experience a sharp drop in demand.

Unemployment is nevertheless expected to increase significantly over the remainder of the forecast period, with the jobless rate rising to almost 6½% (Chart 1.3). This reflects the very weak outlook for demand growth and the standard relationship incorporated into the MPC’s forecast between GDP and employment. A material degree of aggregate economic slack emerges in 2023 Q2, with the output gap rising to 3% of potential GDP by the end of the forecast period (Table 1.A).

In projections conditioned on the alternative assumption of constant interest rates at 3%, the unemployment rate rises by around 1¼ percentage points less in the medium term than in the MPC’s forecast conditional on market rates.

Chart 1.3: Unemployment rate projection based on market interest rate expectations, other policy measures as announced

Footnotes

• The fan chart depicts the probability of various outcomes for LFS unemployment. It has been conditioned on the assumptions in Section 1.1. The coloured bands have the same interpretation as in Chart 1.1, and portray 90% of the probability distribution. The calibration of this fan chart takes account of the likely path dependency of the economy, where, for example, it is judged that shocks to unemployment in one quarter will continue to have some effect on unemployment in successive quarters. The fan begins in 2022 Q3, a quarter earlier than for CPI inflation. That is because Q3 is a staff projection for the unemployment rate, based in part on data for July and August. The unemployment rate was 3.5% in the three months to August, and is projected to be 3.5% in Q3 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.

The risks around the unemployment rate projection are judged to be balanced.

The labour market could remain tight for longer than assumed for a number of reasons, including the upside risks around the outlook for demand themselves (Key judgement 1). For a given demand profile, a greater-than-projected degree of labour hoarding would prolong the tightness in the labour market, although it would not affect the overall degree of slack in the economy. Alternatively, an even greater share of the fall in participation rates during the pandemic than currently assumed could prove to be persistent.

The labour market could also loosen more rapidly than assumed, again including because of the downside risks to demand themselves. Demand for staff is reported to have fallen quite sharply in some business surveys and some indicators of vacancies have declined from their earlier peaks. Labour supply growth could also be affected by how households respond to recent economic developments. Households may seek to boost their real incomes by working more, which could involve those currently inactive re-entering the labour market or those already in the labour force seeking to work longer hours.

Key judgement 3: despite a decline in global price pressures and a significant fall in the contribution of household energy prices to CPI inflation, domestic inflationary pressures remain strong over the next year. But an increasing degree of economic slack depresses domestic pressures further out. Conditioned on the elevated path of market interest rates, CPI inflation declines to below the 2% target in the medium term, although the Committee judges that the risks to the inflation projections are skewed to the upside.

CPI inflation was 10.1% in September and is projected to pick up to around 11% in 2022 Q4 (Section 2.5). This near-term forecast is lower than was expected in the August Report, reflecting the impact of the EPG. As a result, the direct contribution of energy prices to CPI inflation is expected to peak at just under 4 percentage points in 2022 Q4.

Beyond the immediate six-month period of the EPG announced on 17 October and as set out in Box A, the Committee’s assumption of continued fiscal support generates a stylised path for household energy prices over the first two years of the forecast period. This reduces CPI inflation materially relative to the August Report projections that did not assume any fiscal support over this period and were conditioned on a much more elevated level of expected wholesale energy prices. The direct contribution of energy prices to CPI inflation is expected to turn negative from 2024 Q2 onwards. Beyond the two-year period of continued fiscal support, the contribution of household energy prices to inflation remains lower than in the August Report due to the change in the MPC’s conditioning assumption for wholesale energy prices and, in turn, the downward slope of futures curves (Section 1.1).

Bank staff have re-evaluated the transmission of energy costs through supply chains and so the scale of the indirect impact on CPI inflation from high energy prices (Box B). The Committee’s inflation projections now assume that energy prices transmit more quickly through supply chains and to a greater extent than previously assumed. As a result, the effects of past energy price changes are also expected to fade faster than previously assumed.

In part reflecting developments related to the war in Ukraine, UK food price inflation has continued to increase in recent months, and is expected to rise slightly further in the near term.

Sustained disruption to global supply chains, and the shift in global demand towards durable goods and away from services, have put significant upward pressure on tradable goods prices since the pandemic. But there have recently been further signs that global price pressures are falling back. Bottlenecks have started to ease, in part due to the slowdown in global demand, and some global shipping cost indices have fallen sharply (Section 3.1). Bank staff expect world consumer price inflation to peak in 2022 Q4, before falling back substantially over the following year. Four-quarter world export price inflation is also projected to decline sharply over the next year and turn negative in mid-2023.

UK import price inflation is expected to be around 16% in 2022 Q4 and, although it is also expected to fall back materially given the path of world export prices, it will be boosted relative to the August Report by the recent depreciation of sterling.

Not all of the recent excess CPI inflation can be attributed to global events. There has also been a role for interactions of global shocks with domestic factors, including a tight labour market and the pricing strategies of firms. Core services CPI inflation has risen over the past two years and is expected to increase a little further in coming months. Nominal annual private sector regular pay growth rose to 6.2% in the three months to August, 0.6 percentage points higher than expected in the August Report. Bank staff project that underlying pay growth will strengthen further in the near term, and contacts of the Agents have continued to note that, in addition to the tight labour market, inflation is a significant factor in driving pay awards. The Committee has retained its judgement from the August Report that, due to the pressures from pay growth, CPI inflation is a little higher throughout the projection than would otherwise be the case. For example at the two-year horizon, this judgement adds just under ½ percentage point to the inflation projections.

In the MPC’s central projection conditioned on the elevated path of market interest rates, upward pressure on CPI inflation is expected to dissipate, as global commodity price and tradable goods price inflation fall back, and as the contribution to inflation of household energy prices declines more rapidly. Domestic inflationary pressures subside given the increasing degree of economic slack. Earnings growth is expected to start to decline from the second half of next year.

CPI inflation is projected to fall sharply to around 5% by the end of next year (Table 1.C), as fading external factors outweigh domestic pressures. Inflation then falls to 1.4% in two years’ time, below the 2% target, and to 0.0% in three years’ time (Table 1.A), as energy prices make a negative contribution and as domestic pressures weaken further.

Chart 1.4: CPI inflation projection based on market interest rate expectations, other policy measures as announced

Footnotes

• The fan chart depicts the probability of various outcomes for CPI inflation in the future. It has been conditioned on the assumptions in Section 1.1. 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 orange 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 orange area of the fan chart. Over the forecast period, this has been depicted by the 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.

In projections conditioned on the alternative assumption of constant interest rates at 3%, CPI inflation is projected to be 2.2% and 0.8% in two years’ and three years’ time respectively, around three quarters of a percentage point higher than in the Committee’s forecast conditioned on market rates (Chart 1.5).

Chart 1.5: CPI inflation projection based on constant interest rates at 3%, other policy measures as announced

Footnotes

• This fan chart depicts the probability of various outcomes for CPI inflation in the future, conditioned on the assumptions in Section 1.1, apart from for Bank Rate, with this chart conditioned on constant interest rates at 3%. The fan chart has the same interpretation as Chart 1.4.

The risks around the inflation projection are judged to be skewed to the upside in the medium term.

Although uncertainty around the outlook for UK retail energy prices has fallen to some extent following the Government’s announcements of support measures, the precise parameters of support beyond six months are still to be specified. Box A sets out some simple ready reckoners for the impact on inflation (and GDP growth) of different assumptions about the path of household energy bills at the one and two-year forecast horizons.

There remain significant risks around the central projection for CPI inflation from other global and domestic factors.

An upside risk to world prices is that the disruption to the supply of gas from Russia to Europe is greater than embodied in the downward sloping futures curve for wholesale gas prices that now conditions the MPC’s forecast. This would put more upward pressure on global inflation and further restrain activity, although it would have less of a direct impact on the UK inflation outlook given the Committee’s assumptions about continued fiscal support for household energy prices over the next two years. An associated risk to world and UK consumer prices is that disruption to the supply of agricultural products persists for longer due to developments relating to Russia’s invasion of Ukraine. More broadly, even if commodity prices fall back as expected, there could be upside risks to world export price inflation if some companies respond to those declines by rebuilding their profit margins.

There are also some downside risks to world prices if geopolitical tensions and supply disruption ease more quickly, or if there is a sharper‑than‑expected tightening in global financial conditions.

As set out in Box A of the August 2022 Report, there remain a number of risks to the outlook for UK CPI inflation from more persistent strength in domestic wage and price setting.

More persistence in wage and price setting could reflect feedback between high past outturns for CPI inflation, greater confidence by businesses that they can pass on cost increases, and a desire by some employees to try to offset the impact on their real incomes via higher nominal pay. So far, average earnings growth has not kept pace with the rise in CPI inflation. The MPC’s central projections incorporate some attempted catch-up of nominal wage growth to the sharp rise in CPI inflation, which in turn pushes up the inflation projection somewhat. But there remains a risk that firms grant larger pay awards in coming quarters given the tight labour market and the elevated level of CPI inflation. Contacts of the Bank’s Agents have reported that inflation is becoming a more important factor in pay negotiations, and that forthcoming increases in the National Living Wage are also expected by some to influence pay negotiations. That said, previous evidence suggests that there have been limited spillovers of increases in the minimum wage to higher parts of the wage distribution.

How quickly CPI inflation falls back to the 2% target will also depend on inflation expectations. An upside risk to the inflation outlook is that households and firms are less confident that inflation will fall back quickly and do not factor such a decline into their wage and price setting behaviour.

Since the August Report, some indicators of household and business inflation expectations have edged down, although they generally remain at elevated levels. The Bank’s Market Participants Survey reported a further increase in longer-term CPI inflation expectations. The Committee will continue to monitor measures of inflation expectations very closely and act to ensure that longer-term inflation expectations are well anchored around the 2% target.

Domestic prices pressures could be weaker than expected due to the downside risks to demand themselves (Key judgement 1) and hence a greater downward effect on inflation from the degree of spare capacity in the economy. Related, the latest Agency intelligence suggests that, while many firms may continue to pass through higher costs to prices in order to limit a further erosion of margins, others may already be facing constraints on the extent to which they can do so.

Overall, the Committee judges that the risks around the central projection for CPI inflation are skewed to the upside in the medium term. This pushes up on the mean, relative to the modal, inflation projections in the forecast. In particular, on the alternative assumption of constant interest rates at 3%, mean CPI inflation is 2.7% and 1.3% at the two and three-year horizons.

2: Current economic conditions

Chart 2.1: GDP is expected to fall in 2022 H2, unemployment is projected to remain at very low levels and inflation is expected to rise a little in Q4

Near-term projections ^(a)

Footnotes

• Sources: ONS and Bank calculations.
• (a) The lighter diamonds show Bank staff’s projections at the time of the August 2022 Monetary Policy Report. The darker diamonds show Bank staff’s current projections. Projections for GDP and the unemployment rate are quarterly and show Q3 and Q4 (August projections show Q2 to Q4). Projections for CPI inflation are monthly and show October to December 2022 (August projections show July to December 2022). GDP and unemployment rate 2022 Q3 projections are based on official data to August. CPI inflation figure is an outturn.

2.1: Global economy

Global GDP growth has slowed and is projected to remain weak in the near term.

Global GDP growth has been slowing in recent quarters (Chart 2.2). Quarterly UK-weighted world GDP growth is expected to have been around 0.3% in 2022 Q3, similar to Q2, but much weaker than in 2021. The latest indicators, such as cross-country PMIs, suggest that world GDP growth is likely to remain weak in Q4.

In the euro area, GDP growth was 0.2% in Q3 according to the flash estimate, much weaker than the 0.8% growth reported in Q2. The slowdown largely reflects the continuing squeeze on household real incomes due to high energy and food prices. Since August, several European governments have announced a range of policy measures to address the impact of high energy prices on households and businesses. As a result, the growth outlook is stronger than in August (Table 1.D).

In the United States, GDP grew by 0.6% in Q3, having fallen slightly in the previous two quarters. Growth was boosted by net trade in particular, with a rise in both goods and services exports, and a fall in goods imports. Nevertheless, financial conditions in the US continued to tighten, as the FOMC has tightened monetary policy in response to inflationary pressures. This has also contributed to a slowing in the US housing market. Tighter financial conditions are expected to continue to weigh on growth.

In China, GDP growth picked up to 3.9% in Q3, as Covid-related restrictions were loosened. Accommodative monetary and fiscal policies also boosted growth. Looking ahead, the ongoing impact of Covid-related restrictions, weakness in the housing sector and a slowing in global demand are expected to weigh on growth.

Chart 2.2: Global growth has slowed and is projected to remain weak in Q4

UK-weighted world GDP growth ^(a)

Footnotes

• Sources: Refinitiv Eikon from LSEG and Bank calculations.
• (a) See footnote (c) of Table 1.D for definition. Figures for 2022 Q3 and Q4 are Bank staff projections. These projections do not include the Advance Estimate of US 2022 Q3 GDP and the Preliminary Flash Estimate of euro-area 2022 Q3 GDP which were released after data cut-off.

Consumer price inflation in the euro area and US remains elevated.

In the euro area, annual HICP inflation picked up to 9.9% in September. Energy prices continued to make the largest contribution to headline inflation, similar to the UK (Chart 2.4). European gas spot prices picked up sharply in August, but have since fallen back markedly (Chart 2.3). This was partly driven by the build-up of gas stocks in many European countries ahead of the winter. Gas futures prices remain elevated though, which reflects the ongoing impact of Russia’s restriction of gas supplies to Europe. As in the UK, measures announced by some European countries to limit the pass-through of higher wholesale gas prices into retail energy prices are expected to reduce the near-term path of inflation relative to projections in August.

Chart 2.3: Spot gas prices have fallen from their August peaks in Europe and the UK

International wholesale gas spot and futures prices ^(a)

Footnotes

• Sources: Bloomberg Finance L.P. and Bank calculations.
• (a) The Dutch Title Transfer Facility pricing point is used for the European price. UK and US prices have been converted to euros. Dashed lines refer to respective futures curves using one-month forward prices based on the seven day average to 25 October 2022 for the UK and the fifteen day averages to 25 October 2022 for the US and Europe.

In the United States, annual headline CPI inflation was 8.2% in September, having fallen from its recent high of 9.1% in June (Chart 2.4). Annual headline PCE inflation, the FOMC’s target variable, was 6.2% in September. That is lower than its recent peak in June, largely due to a fall in fuel prices. As discussed in Box E in the August Report, services inflation has been higher in the US and UK than in the euro area, which in part is likely to reflect greater labour market tightness.

Chart 2.4: Inflation remains elevated in the UK, US and euro area

Contributions to annual consumer price inflation ^(a)

Footnotes

• Sources: Eurostat, ONS, Refinitiv Eikon from LSEG, US Bureau of Economic Analysis, US Bureau of Labor Statistics and Bank calculations.
• (a) Energy includes fuel and household energy bills. Other goods is the difference between overall inflation and the other contributions identified on the chart, and therefore includes alcohol and tobacco. The latest data are September 2022 outturns.

An easing of global bottlenecks and the fall in commodity prices should help to reduce global inflationary pressures.

Global bottlenecks have eased as supply conditions have improved and global demand has slowed. Global shipping costs have fallen from their peaks earlier in the year (Chart 3.5) and other indicators of supply constraints point to an easing of pressures in the past few months.

Weaker global demand is also weighing on the prices of some commodities, such as oil and metals, which have fallen since August (Chart 2.5). The Brent crude oil spot price has fallen by just under 15%, though it remains 20% higher than at the start of the year. Global agricultural goods prices have picked up a little, reflecting some weather-related supply disruption over the summer, but have fallen by around 20% from their recent peak in Q2.

In the MPC’s baseline projection, global bottlenecks are expected to ease further which should help to reduce inflationary pressures for tradable goods. Assuming that energy prices follow their futures curves, four-quarter world export price inflation is projected to fall sharply during 2023 (Section 1).