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 10 May 2023, the MPC voted by a majority of 7–2 to increase Bank Rate by 0.25 percentage points, to 4.5%. Two members preferred to maintain Bank Rate at 4.25%.

The Committee’s updated projections for activity and inflation are set out in the accompanying May Monetary Policy Report. They are conditioned on a market-implied path for Bank Rate that peaks at around 4¾% in 2023 Q4 before ending the forecast period at just over 3½%.

There has been upside news to the near-term outlook for global activity, with UK-weighted world GDP now expected to grow at a moderate pace throughout the forecast period. Risks remain but, absent a further shock, there is likely to be only a small impact on GDP from the tightening of credit conditions related to recent global banking sector developments. Headline inflation has been falling in the United States and euro area, although core inflation measures remain elevated.

UK GDP is expected to be flat over the first half of this year, although underlying output, excluding the estimated impact of strikes and an extra bank holiday, is projected to grow modestly. Economic activity has been less weak than expected in February, and the Committee now judges that the path of demand is likely to be materially stronger than expected in the February Report, albeit still subdued by historical standards. The improved outlook reflects stronger global growth, lower energy prices, the fiscal support in the Spring Budget, and the possibility that a tight labour market leads to lower precautionary saving by households.

Although there are indications that the labour market has started to loosen, it is expected to remain tighter than in the February Report in the near term. The unemployment rate is now projected to remain below 4% until the end of 2024, before rising over the second half of the forecast period to around 4½%.

CPI inflation was 10.2% in 2023 Q1, higher than expected at the time of the February and March MPC meetings, with the upside surprise concentrated in core goods and food prices. Although still elevated, nominal private sector wage growth and services CPI inflation have been close to expectations.

CPI inflation is expected to fall sharply from April, in part as large rises in the price level one year ago drop out of the annual comparison. In addition, the extension in the Spring Budget of the Energy Price Guarantee and declines in wholesale energy prices will both lower the contribution from household energy bills to CPI inflation. However, food price inflation is likely to fall back more slowly than previously expected. Alongside news in other goods prices, this explains why the Committee’s modal expectation for CPI inflation now falls back more slowly than in the February Report.

In the MPC’s latest modal projection conditioned on market interest rates, CPI inflation declines to a little above 1% at the two and three-year horizons, materially below the 2% target. This reflects the emergence of an increasing degree of economic slack and declining external pressures that are expected to reduce CPI inflation. However, there remain considerable uncertainties around the pace at which CPI inflation will return sustainably to the 2% target. The Committee continues to judge that the risks around the inflation forecast are skewed significantly to the upside, reflecting the possibility that the second-round effects of external cost shocks on inflation in wages and domestic prices may take longer to unwind than they did to emerge. The mean CPI inflation profile, which incorporates this risk, is at or just below the 2% target in the medium term.

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 sequence of very large and overlapping 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 Committee has voted to increase Bank Rate by 0.25 percentage points, to 4.5%, at this meeting. In doing so the MPC is continuing to address the risk of more persistent strength in domestic price and wage setting, as represented by the upward skew in the projected distribution for CPI inflation.

The pace at which domestic inflationary pressures ease will depend on the evolution of the economy, including the impact of the significant increases in Bank Rate so far. Uncertainties around the global financial and economic outlook remain elevated.

The MPC will continue to monitor closely indications of persistent inflationary pressures, including the tightness of labour market conditions and the behaviour of wage growth and services price inflation. If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required.

The MPC will adjust Bank Rate as necessary to return inflation to the 2% target sustainably in the medium term, in line with its remit.

1: The economic outlook

1.1: The conditioning assumptions underlying the MPC’s projections

As set out in Table 1.B, the MPC’s projections are conditioned on:

• The paths for policy rates implied by financial markets, which are higher than in the February Report, as captured in the 15-working day average of forward interest rates to 28 April (Chart 2.5). In the United Kingdom, the market-implied path for Bank Rate now peaks at around 4¾% in 2023 Q4, up from just under 4½% at the time of the February Report, and ends the forecast period at just over 3½%. This latest UK interest rate path is still below the level prevailing at the time of the November 2022 Report, which followed the volatility in UK interest rate markets seen in late September and early October, but well above levels seen earlier last year.
• A path for the sterling effective exchange rate index that is nearly 1½% stronger on average than in the February Report, but is depreciating gradually over the forecast period given the role for expected interest rate differentials in the Committee’s conditioning assumption.
• Fiscal policy that evolves in line with announced Government policies to date. Since the February Report, the Government has announced a range of additional fiscal support in the Spring Budget, including further energy support measures for households and businesses, temporary 100% capital allowances for qualifying business investment undertaken between 2023–24 and 2025–26, a package of measures aimed at increasing labour market participation, higher defence spending and a freeze in fuel duty in 2023–24. Regarding energy policy, the Government announced that the Energy Price Guarantee (EPG) is now being maintained at £2,500 for a household with typical energy use, for the three months from April, rather than increasing to £3,000 as was planned in the Autumn Statement. During the forecast period, the overall impact of fiscal policy on the economy includes the news in the Budget alongside all previous measures, some of which were only a temporary loosening in fiscal policy (Key judgement 2).
• Wholesale energy prices that follow their respective futures curves over the whole forecast period, as was the case in the February 2023 and November 2022 Reports. Since February, spot gas prices have declined further, to below the level seen before Russia’s invasion of Ukraine in early 2022 though not to the average price prevailing prior to mid-2021, and the gas futures curve has also moved lower (Chart 2.2). Over the longer period since last summer, the end point of the MPC’s wholesale gas price conditioning assumption has fallen back notably (Chart 1.1), reducing the scale of the external cost shock facing the UK economy. Significant uncertainty remains around the outlook for wholesale energy prices, and the Committee will keep its wholesale energy price conditioning assumption under review.

Chart 1.1: Wholesale gas spot price and forecast conditioning assumptions for wholesale gas prices ^(a)

Footnotes

• Sources: Bloomberg Finance L.P. and Bank calculations.
• (a) Spot price is the one-day forward price of UK natural gas. The projections in May 2023, February 2023 and November 2022 are conditioned on wholesale gas prices following futures curves. These futures curves are the 15 working day averages to 28 April 2023 and 24 January respectively for May and February 2023 and the seven working day average to 25 October 2022 for November 2022. The projections in August 2022 were conditioned on wholesale gas prices following the futures curve in the 15 working days to 26 July for the first six months and then remaining constant.

• The EPG ceasing to bind on household energy prices from 2023 Q3 onwards, as was the case in the February Report. Instead, household prices are assumed to fall back in line with Bank staff estimates of the Ofgem price cap implied by the lower path of wholesale energy prices.

1.2: Key judgements and risks

Key judgement 1: global GDP is expected to grow at a moderate pace throughout the forecast period, albeit a little more rapidly than expected previously in the near term. Risks remain but, absent further shocks, there is likely to be only a small impact on GDP from the tightening of credit conditions related to recent global banking sector developments.

Bank failures have, alongside broader macroeconomic developments, resulted in global financial market asset price volatility since the February Report. Equity prices have generally recovered after experiencing sharp falls in March (Chart 2.6), and 10-year government bond yields have ended the period broadly unchanged since February in the United States and slightly higher in the euro area. Banks’ bond spreads initially widened by around 40 to 80 basis points in these economies, before falling back to some degree.

In the MPC’s modal projections, the impact of recent banking stresses on global financial conditions and the international economic outlook is expected to be quite small. Credit conditions in the United States are assumed to tighten to some extent in response to recent events, with a peak impact on US GDP of around -¼% next year. That reflects developments in aggregate bank funding costs and an additional judgement that smaller US banks are likely to restrict their business lending activity to help to offset recent deposit outflows, with some potential borrowers unable to substitute away from small bank credit in the short term. The impact of recent banking sector developments on growth in the euro area is expected to be considerably smaller.

The Bank of England’s Financial Policy Committee (FPC) has continued to brief the MPC about recent banking sector developments. The FPC continues to judge that the UK banking system is resilient, maintaining robust capital and strong liquidity positions. It is resilient to the current economic outlook, and has the capacity to support the economy in a period of higher interest rates even if economic conditions are worse than forecast. The FPC is monitoring developments in other jurisdictions closely in light of the risk that indirect spillovers from overseas banks impact the wider UK financial system.

Spreads on UK banks’ wholesale funding also rose in March before falling back. The impact of recent global banking sector developments on domestic credit conditions, and hence UK GDP growth, is expected to be small (Section 2.2). The MPC will continue to monitor closely any effects on the credit conditions faced by households and businesses.

Global growth has been more resilient than expected to the headwinds from a range of shocks hitting the world economy. In the May Report projections, UK-weighted world GDP is estimated to have grown by 0.6% in 2023 Q1 and to grow by around 0.4% in Q2, both stronger than expected in the February Report with broad-based upward revisions across regions (Section 2.1).

Alongside its judgement to push up UK GDP growth in this forecast (Key judgement 2), the Committee also expects somewhat stronger world GDP growth. The euro-area economy in particular appears to be more resilient to the shock from energy prices, which has in any case unwound further. High current storage levels of gas reduce any potential downside risks to euro-area growth if energy supplies were to come under threat again.

Euro-area GDP is expected to grow at a moderate pace over the first half of the forecast period, as real incomes remain squeezed and tighter monetary policy weighs on activity. In the United States, growth is projected to slow in the middle of this year, in part reflecting the expected impact of tighter monetary policy and credit conditions, before recovering over the remainder of the forecast period. Following an earlier-than-anticipated rebound in activity after the end of its zero-Covid policy, Chinese growth is projected to slow to trend over the remainder of 2023.

Overall, in the MPC’s modal projection, UK-weighted world GDP growth is projected to slow from 3% in 2022, to 1¾% in 2023 and 2024, before rising to just over 2% in 2025 (Table 1.D). That compares with average annual growth of around 2½% in the decade prior to the pandemic. Growth is expected to be stronger this year than in the February Report.

There are risks in both directions around the projection for world GDP growth.

Growth in advanced economies could be stronger than expected if recent resilience in demand and tightness in labour markets were to continue to a greater extent than assumed in the May modal projections. There is a downside risk to international activity if recent overseas banking sector stresses were to spread more widely through the global financial system, or if the stresses were to have larger impacts on activity in their domestic economies than in the modal projections, including via broader channels onto business and household confidence.

Key judgement 2: the Committee judges that UK GDP growth over much of the forecast period will be materially stronger than in the February Report, although past increases in Bank Rate and the path of market interest rates, alongside a waning boost from looser fiscal policy and relatively weak potential supply, weigh on UK GDP in the medium term.

UK GDP is expected to be broadly flat during the first half of this year. However, excluding the impact of idiosyncratic factors such as public sector strikes and the additional bank holiday for the King’s Coronation, the economy is projected to grow by around 0.2% in both 2023 Q1 and Q2. This rate of underlying growth is materially stronger than expected in the February Report. The Bank’s Agents have also reported recently that activity has been stronger than their contacts previously expected (Box C). In the March Bank/NMG survey, households were more optimistic about the general economic situation and their income and employment prospects than in the previous survey last September. The final S&P Global/CIPS UK composite PMI data for April reinforced recent signs of a strengthening in underlying activity in the economy.

The downward adjustment to the EPG in 2023 Q2 and the continued fall in wholesale, and hence prospective household and business, energy prices since the February Report (Section 1.1) are reducing further the drag on GDP from the real income squeeze and are likely to explain some of the upside news in near-term growth.

The Committee has made a material judgement in this forecast to boost the expected path of demand. This reflects a number of factors, including the possibility in the short term that the economy is more resilient to the energy price shock than expected previously. This channel is also judged to be relevant for the outlook for euro-area growth (Key judgement 1) and so stronger world activity spills back on to the United Kingdom via both trade and investment channels.

Stronger demand in this forecast also reflects the possibility of lower precautionary saving by households than previously assumed, in turn related to a lower risk of job loss. Given the strength of the labour market and the historically very large number of vacancies in the economy, the Committee made a judgement in the February Report that any reduction in labour demand was likely to lead to fewer redundancies than in previous cycles. Some of the latest upside news in near-term GDP could be consistent with such a channel operating to a greater degree than anticipated.

The MPC’s latest judgement on demand also means that growth excluding idiosyncratic factors is expected to remain positive beyond the first half of this year, consistent with business surveys and other indicators of near-term growth prospects.

The pass-through of past increases in Bank Rate and the latest, slightly higher, market-implied interest rate path (Section 1.1) continue to push down on GDP over the forecast period. As set out in Box B, the direct cash-flow channel of monetary policy, which tends to reduce spending when interest rates rise, is operating broadly as expected during the current tightening cycle, although the greater share of fixed-rate mortgages means that it is likely to operate more slowly than in the past. Given such lags in monetary policy transmission, the rise in Bank Rate since December 2021 is expected to weigh to an increasing degree on the economy in coming quarters.

The fiscal measures announced in the Spring Budget (Section 1.1) are expected to boost GDP over the forecast, building to a peak impact of around ½% by the end of the period. This is a slightly larger impact than the 0.3% provisional estimate noted in the March MPC minutes, following a fuller staff assessment during this forecast round. The bulk of the boost to GDP is assumed to come from the temporary 100% capital allowances for qualifying business investment undertaken between 2023–24 and 2025–26, and from the package of measures aimed at increasing labour market participation (Key judgement 3), both of which are assumed to have some positive effects on potential supply in the forecast.

Taking account of all announced government plans, fiscal policy generally pulls down on GDP growth over much of the forecast period, as the positive impacts of past loosening measures, some of which were only temporary, on the level of GDP at the start of the forecast unwind.

In the Committee’s May modal projection, underlying GDP growth is projected to remain slightly positive in 2023 Q3 and over the rest of the forecast period, picking up a little further during the final year of the projection. This is a materially stronger profile than in the February Report, when quarterly growth rates were expected to be negative until 2024 Q1. The path of market interest rates, including the impact of increases in Bank Rate to date, and a waning boost from looser fiscal policy continue to weigh on GDP, however, and the path of demand also reflects the relatively weak potential supply projection (Key judgement 1 in the February 2023 Report). Calendar-year GDP growth is expected to be ¼% in 2023, and ¾% in 2024 and 2025 (Table 1.D). Four-quarter GDP growth picks up to almost 1¼% by 2026 Q2 (Chart 1.2), although this remains below pre-pandemic rates.

Relative to the February projection, GDP is around 2¼% higher by the end of the forecast period, with around half of that change reflecting demand news and the MPC’s judgement, and the other half accounted for by positive news in potential supply. That, in turn, reflects in part developments in fiscal policy, including the package of labour participation measures, as well as a stronger population forecast (Key judgement 3). Relative to the very downbeat GDP projections that the Committee published during the second half of last year, the outlook is now considerably less weak, in large part reflecting successive reductions in the wholesale energy price assumptions conditioning the forecast (Chart 1.1) as well as fiscal support.

Within the components of GDP underpinning the May modal projection, calendar-year household spending is expected to rise by ¾% in both 2023 and 2024 and by 1% in 2025 (Table 1.D). Real post-tax household income is projected to grow by 1% in each of these calendar years, and the household saving ratio is expected to be broadly flat over the forecast period. The paths of both consumption and disposable income are materially stronger than in the February Report.

Business investment is expected to fall by ¼% in 2023 and to be flat in 2024, before recovering by 1½% in 2025. This profile is much stronger than in the February Report, reflecting news in recent data, the stronger demand profile and an estimated boost of 3% to 3½% in 2024–25 and 2025–26 from the announcement in the Budget of a temporary increase in capital allowances for investment (Section 2.3).

In large part reflecting the transmission of tighter monetary policy, housing investment is expected to fall by 4½% in 2023, by 3¾% in 2024 and by ½% in 2025. Some recent housing and mortgage data have been less weak than in previous months, however.

Chart 1.2: 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 Bank Rate following a path implied by market yields, but allows the Committee’s judgement on the risks around the other conditioning assumptions set out in Section 1.1, including wholesale energy prices, to affect the calibration of the fan chart skew. 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.

In the GDP projection conditioned on the alternative assumption of constant interest rates at 4.5%, growth is weaker than in the MPC’s forecast conditioned on market rates.

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

As set out in the Annex of this Report, external forecasters’ average medium-term projections for GDP remain stronger than the MPC’s, even after the upward revision to demand in this projection. This could imply an upside risk to the MPC’s growth projection, although it is difficult to make precise comparisons due to potential differences in conditioning assumptions between forecasters. Conversely, demand could be weaker than expected if some people become more worried about their job security and try to build up their savings to a greater extent, or if some mortgagors who need to refinance in the future take advance actions to prepare for spending more on interest costs.

More generally, the MPC’s aggregate projections are constructed based in large part on the average relationships over the past between Bank Rate, other financial instruments and economic activity. The Committee will continue to keep these relationships under review, including how they may have changed during the current monetary policy tightening cycle.

Key judgement 3: the UK economy is judged to have been in excess demand over recent quarters, but a degree of economic slack is expected to emerge from the end of this year.

The Committee judges that there has been a significant margin of excess demand in the economy over recent quarters, in part reflecting the weakness of potential supply. In the latest forecast, excess demand has been accounted for by both a higher than normal degree of capacity utilisation within companies and by the tightness of the labour market. Relative to the February Report, there is judged to have been a slightly greater margin of excess demand near the end of last year than estimated previously, with more upside news during the first half of this year.

There are indications that the labour market has started to loosen but it is expected to remain tighter than in the February Report (Section 3.2). The unemployment rate was 3.8% in the three months to February, slightly below the MPC’s assessment of the medium-term equilibrium rate of unemployment. A fall in the inactivity rate has been the counterpart to a faster-than-expected rise in employment in recent data (Section 2.3). But a stronger near-term outlook for employment is also reflected in a lower expectation for the unemployment rate, which is now projected to remain at 3.8% in 2023 Q2, compared to the 4.1% forecast at the time of the February Report. While the ratio of vacancies to unemployment remains elevated, it has fallen from its peak in 2022, and job-to-job flows have declined (Chart 3.4). The Bank’s Agents have also reported an easing in recruitment difficulties.

Reflecting the measures in the Budget, including reforms to funding for childcare, the Committee judges that the potential participation rate is likely to be somewhat higher than it would otherwise have been in the medium term, pushing up on potential labour supply. Supply is also being boosted over the forecast period by stronger population growth, as the ONS has revised up its population projections.

Although supply is expected to remain relatively weak, the headwinds to demand from both the path of market interest rates and fiscal policy lead to some degree of economic slack emerging in the Committee’s projections from the end of this year. As has been the case in recent forecasts, companies are expected to respond to this weakness in demand by retaining their existing workers, while using them less intensively and hoarding labour for a prolonged period. That is broadly consistent with capacity utilisation falling back rapidly at the start of this year and remaining some way below normal for much of the remainder of the forecast period. As a result, the labour market is expected to remain fairly tight in the near term. In the MPC’s May modal projection, the unemployment rate is projected to remain below 4% until the end of 2024, rather than rising towards 5% as expected in the February Report.

During the second half of the forecast period, unemployment is expected to increase somewhat, with the jobless rate rising to around 4½% by 2026 Q2 (Chart 1.3). Even though this is accompanied by some rise in the medium-term equilibrium rate of unemployment, the increase in the actual unemployment rate leads to a widening degree of spare capacity in the labour market. Overall, the margin of aggregate excess supply is expected to widen to -1% of potential GDP by the final year of the forecast period (Table 1.A). Both aggregate spare capacity and particularly the unemployment rate increase by much less in the Committee’s latest projections than in the February Report.

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 Bank Rate following a path implied by market yields, but allows the Committee’s judgement on the risks around the other conditioning assumptions set out in Section 1.1, including wholesale energy prices, to affect the calibration of the fan chart skew. The coloured bands have the same interpretation as in Chart 1.2, and portray 90% of the probability distribution. The fan begins in 2023 Q1, a quarter earlier than for CPI inflation. That is because Q1 is a staff projection for the unemployment rate, based in part on data for January and February. The unemployment rate was 3.8% in the three months to February, and is also projected to be 3.8% in Q1 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.

In projections conditioned on the alternative assumption of constant interest rates at 4.5%, the unemployment rate rises by more in the medium term than in the MPC’s forecast conditional on market rates.

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

As discussed in the February Report, it remains difficult to distinguish the extent to which developments in labour market participation are persistent or temporary, and the extent to which they may be having an impact on spare capacity in the economy.

It is possible that there has been more persistence in labour market frictions and mismatch than assumed, pushing up on the medium-term equilibrium rate of unemployment to a greater degree than in the modal projection. This would suggest that the labour market has been tighter than the Committee has assumed and would be consistent with greater upward pressure on wage growth (Key judgement 4).

The labour market could remain tight for longer than assumed for a number of other reasons, including the upside risks around the outlook for demand themselves (Key judgement 2). For a given demand profile, an increase in labour hoarding could prolong the tightness in the labour market, although it may not affect the overall degree of slack in the economy. Conversely, the labour market could loosen more rapidly than assumed, again including because of any downside risks to demand themselves.

Key judgement 4: CPI inflation is expected to fall sharply as energy costs begin to ease. In the modal forecast conditioned on market interest rates, an increasing degree of economic slack and declining external pressures lead inflation to fall to materially below the 2% target in the medium term, but the Committee continues to judge that the risks to that forecast are skewed significantly to the upside. The mean projection for CPI inflation, which incorporates these risks, is at or just below the 2% target in the medium term.

CPI inflation remains well above the 2% target and, at 10.2% in 2023 Q1, was higher than projected in the February Report. Inflation is expected to fall sharply from April, declining to an average of 8.2% in 2023 Q2, 7.0% in Q3 and 5.1% in Q4 (Table 1.C). That near-term fall in inflation reflects three main factors: large rises in the price level one year ago dropping out of the annual comparison, domestic energy prices starting to fall and a wider decline in input cost pressures (Section 2.4).

The direct contribution of energy prices to CPI inflation is expected to decline rapidly over coming quarters and to turn negative by the end of the year, based on recent wholesale energy price developments (Section 1.1). The adjustment to the EPG in the Budget represents immediate downside news to the outlook for household energy prices, lowering directly the forecast for CPI inflation in 2023 Q2 by around 1 percentage point relative to the February Report. The Ofgem price cap is assumed to operate thereafter, with household energy costs falling back in line with the lower path of wholesale gas prices. Over the second and third years of the forecast period, the direct energy contribution to inflation is expected to be either around zero or slightly negative, based on the downward slope of wholesale futures curves.

Almost all of the upside news in CPI inflation data since the February Report has been accounted for by developments in food and other goods prices. Food price inflation picked up to almost 20% in March (Section 2.4). Bank staff analysis suggests food inflation has been stronger than implied by developments in global agricultural commodity prices alone, reflecting Russia’s invasion of Ukraine and wider pressures along the supply chain. Indicators continue to suggest that food price inflation will decline in coming months, but it is now forecast to do so at a slower pace than expected in the February Report. As a result, the Committee judges that food prices will boost CPI inflation by around an additional 1 percentage point in the middle of the forecast period relative to the February Report, although this is not expected to persist further out.

Core goods price inflation has remained around 5½% to 5¾%, in contrast to the decline to just over 4% expected in the February Report, with particular strength in clothing prices. Other, potentially leading, indicators of goods prices have continued to weaken, however. Global supply chain conditions have loosened further. Shipping rates have stabilised at around pre-pandemic levels and so well below the rates available last year. The Bank’s Agents have reported growing confidence among many non-food retail contacts that goods price inflation will ease through the year, reflecting improved supply and lower transport costs. In the latest Decision Maker Panel Survey, companies’ expectations of their own-price inflation for the year ahead were stable over the past three months, around 2 percentage points lower than their estimates of realised inflation, implying that businesses expect their own-price inflation to fall over the coming year.

Four-quarter UK-weighted world export price inflation, excluding the direct effect of oil prices, is expected to turn negative in 2023 Q2, before picking back up to be slightly positive in the second half of the forecast period. This is a somewhat stronger medium-term profile for world export prices than in the February Report, reflecting a judgement that some determinants of global prices are unlikely to return to their pre-pandemic trends. The recent appreciation of the sterling exchange rate (Section 1.1) will put some downward pressure on UK import price inflation, and over time on CPI inflation, relative to the February Report. Taken together, import prices are projected to fall by 8¼% in 2023, by 2¾% in 2024 and to be flat in 2025, weaker in the near term and somewhat stronger in the medium term than in the February Report (Table 1.D).

Domestic inflationary pressures have remained elevated, reflecting indirect effects from past energy price increases and some second-round effects. Services CPI inflation was 6.6% in March, in line with expectations in the February Report, and reflecting the strength of nominal pay growth and, to a lesser degree, non-labour input costs. Services CPI inflation is projected to remain elevated in the near term (Chart 3.8), although the moderation of energy and other input cost pressures could start to exert some downward pressure quite soon.

Annual private sector regular pay growth has eased slightly, to 6.9% in the three months to February (Chart 3.5), close to expectations in the February Report. On a three-month on three-month annualised basis, private sector regular pay growth has fallen significantly, from a peak of 9.0% in July to 5.6% in February. Annual growth is expected to continue to decline, to around 5½% by the end of this year and to around 3% by the end of the forecast period, as short-term inflation expectations are assumed to fall back and a margin of spare capacity is expected to open up in the labour market in the medium term. The Committee has retained its judgement from recent Reports that, owing to the pressures from pay growth, CPI inflation is a little higher throughout the projection than would otherwise be the case. The medium-term path of pay growth is somewhat stronger in the latest projection than in the February Report.

The much less negative output gap profile in the latest forecast, in part reflecting the MPC’s judgement to push up demand (Key judgement 2), increases CPI inflation and pay growth throughout the forecast period. In the medium term, the inflation projection is just under ½ percentage point higher due to this channel, relative to the February Report.

In the MPC’s modal projection conditioned on the path of market interest rates, CPI inflation declines to materially below the 2% target in the medium term, as an increasing degree of economic slack is expected to reduce domestic inflationary pressures, alongside a slightly negative contribution from energy and other import prices. CPI inflation is projected to fall to around 2% by the end of next year, and to be 1.1% at the two-year horizon and 1.2% in three years (Table 1.C and Chart 1.4).

Compared with the equivalent February Report projection, CPI inflation is expected to fall back to the 2% target somewhat less rapidly in the middle of the forecast period and hence return to target around three quarters later. This is accounted for in large part by higher expected food price inflation. CPI inflation is somewhat higher in the medium term than in February, largely reflecting the reduction in the projected margin of excess supply in this forecast, although it is still below target in the modal projection.

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 Bank Rate following a path implied by market yields, but allows the Committee’s judgement on the risks around the other conditioning assumptions set out in Section 1.1, including wholesale energy prices, to affect the calibration of the fan chart skew. 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 the modal projection conditioned on the alternative assumption of constant interest rates at 4.5%, CPI inflation is projected to be 0.7% and 0.9% in two years’ and three years’ time respectively, lower than the Committee’s forecasts at the same horizons conditioned on market rates.

The path for inflation beyond the near term is uncertain, and the risks around the modal projection are judged to remain skewed significantly to the upside.

Against the backdrop of limited spare capacity in the economy, sharp rises from 2021 in world export and commodity prices have resulted in indirect effects and second-round effects on domestic costs and prices. Since last summer most of these global prices have stopped rising. More significantly, given its recent contribution to CPI inflation, there have also been declines in wholesale gas prices in recent months. Nevertheless, there remain considerable uncertainties around the pace at which CPI inflation will return sustainably to the 2% target. The Committee has considered a range of analysis by Bank staff concerning the persistence of inflation in wages and domestic prices.

Some of this analysis supports the view that there are non-linearities in the way inflation reacts to changes in demand. In particular, there is some evidence that the response is greater, to any given increase in demand, when spare capacity is more limited to begin with. Such non-linearities might help to explain some of the recent strength in domestic inflation, given the low level of unemployment. In and of themselves, however, they would not result in greater persistence of inflation. Were the labour market to loosen, equally marked effects in the other direction would be expected.

More relevant may be the potential asymmetry in the second-round effects of changes in import prices. The steep rises in global goods prices weighed heavily on UK real incomes in 2021 and much of 2022. In an effort to protect these incomes, whether wages or profits, employees and domestic firms have sought compensation in the form of higher nominal pay and domestic selling prices. As global prices cease to rise, and in some cases reverse, this should in time reduce the corresponding pressure on domestic inflation. But, to the extent that employees and firms are still seeking to recoup lost incomes, this unwinding of second-round effects may take longer than it did for them to emerge. The current circumstances are highly unusual. As such, it is hard to be precise about the extent of this asymmetry. Nevertheless, the Committee has for this reason judged that, relative to a modal expectation of significant declines in domestic inflation, there remain material upside risks over the medium term.

The pace at which 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. Developments in more visible components of inflation, such as energy and food prices, will have an important impact on inflation perceptions and expectations. Since the February Report, indicators of household inflation expectations have been broadly unchanged at elevated levels (Chart 3.7). Companies’ inflation expectations have fallen back a little. Medium-term inflation compensation measures in financial markets have risen somewhat and remain above their long-term averages. 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.

In addition, there are upside risks around the modal projection for UK CPI inflation from international factors. There remains the possibility of more persistence in consumer price inflation in the UK’s major trading partners, for similar reasons to the risks of stronger domestic inflationary pressures at home. Any fragmentation of global supply chains and hence extra costs associated with reshoring production could also lead to stronger world export price inflation in the medium term.

The Committee has considered incorporating some of the additional factors suggesting more persistence into the modal projection for CPI inflation in this forecast, but judges that those are better reflected in a large upside skew as they are inherently difficult to quantify more precisely. Overall, the Committee therefore continues to judge that the risks around the modal projection for CPI inflation are skewed significantly to the upside, primarily reflecting the possibility of more persistence in domestic wage and price setting. This pushes up on the mean, relative to the modal, inflation projections in the forecast. Conditioned on market interest rates, mean CPI inflation falls back to 1.9% and 2.0% at the two and three-year horizons respectively.

2: Current economic conditions

Chart 2.1: GDP and the unemployment rate are expected to be broadly flat in 2023 H1 but inflation is expected to fall sharply

Near-term projections ^(a)

Footnotes

• Sources: ONS and Bank calculations.
• (a) The lighter diamonds show Bank staff’s projections at the time of the February 2023 Monetary Policy Report. The darker diamonds show Bank staff’s current projections. Projections for GDP growth and the unemployment rate are quarterly and show 2023 Q1 and 2023 Q2 (February projections show Q4 to Q2). Projections for CPI inflation are monthly and show April to June 2023 (February projections show January to June 2023). GDP growth and unemployment rate 2023 Q1 projections are based on official data to February, the CPI inflation figure is an outturn.

2.1: Global economy and financial markets

Global growth has been stronger in early 2023 than expected in the February Report.

UK-weighted world GDP is expected to have grown by 0.6% in 2023 Q1, 0.6 percentage points stronger than expected in the February Report. This outperformance has been broad-based and Bank staff expect all of the UK’s main trading partners to have performed more strongly than previously forecast. Staff expect world GDP growth in 2023 Q2 to be around 0.4%, slightly stronger than the February Report. Nevertheless, while global growth has been more resilient than expected, it is still subdued. Four-quarter growth in 2023 Q2 is expected to be 1.9%, a little below its average rate over 2010–19 of 2.1%.

Euro-area GDP grew by 0.1% in 2023 Q1 according to the preliminary flash release, stronger than the decline expected in the February Report. The economy has been more resilient than expected to the previous sharp rise in energy prices, while stronger growth in China has supported exports. GDP growth is expected to be 0.2% in 2023 Q2.

In the United States, GDP grew by 0.3% in 2023 Q1 which was also stronger than expected in the February Report. This outperformance was more than accounted for by household consumption, which has been supported by both strength in the labour market and increased income tax thresholds that came into effect in January. Staff expect GDP growth to slow to 0.1% in 2023 Q2, as tighter credit conditions and the effects of tighter monetary policy weigh on activity.

In China, GDP grew by 2.2% in 2023 Q1, much stronger than the contraction expected in the February Report. The wave of Covid cases that followed the lifting of restrictions has dissipated faster than expected, and the resulting impact on activity has been smaller. GDP is expected to grow by 1.1% in 2023 Q2, led by services activity and consumption growth.

Wholesale gas prices have fallen since February…

Since the February Report, gas prices have fallen further. European wholesale spot gas prices, as indicated by the Dutch Title Transfer Facility price, have fallen by nearly 40% to €40 per MWh (Chart 2.2). This leaves spot gas prices below the level seen before Russia’s invasion of Ukraine in February 2022, although still over three times above their average level in 2020. The gas futures curve has also moved lower as milder weather, reduced energy consumption and fuel switching have bolstered storage levels. In the UK, wholesale gas prices have also moved lower in line with continental European prices.

Brent crude oil spot prices fell in the days following the failure of Silicon Valley Bank as fears of economic disruption and reduced demand weighed on prices. Oil prices are now broadly unchanged from their February levels. Among non-energy commodities, agricultural goods prices have risen slightly since February while industrial metals prices are around 6% lower.

Chart 2.2: Gas prices have declined since the February Report

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 prices have been converted to euros. Dashed lines refer to the 15-day average to 24 January 2023. Dotted lines refer to the 15-day average to 28 April 2023.

…and supply-chain pressures continue to ease.

Measures of global supply chain pressures have continued to ease since February (Chart 2.3), aided by the reopening of the Chinese economy. Measures of shipping costs have fallen significantly and are now around pre-pandemic levels. These developments suggest that the marked decline in world export price inflation over the course of 2023 that was projected in the February Report is broadly on track.

Chart 2.3: Supply chain constraints have continued to ease

Indicators of supply constraints ^(a)

Footnotes

• Sources: Refinitiv Eikon from LSEG, S&P Global/CIPS and Bank calculations.
• (a) Indicators are estimated by Bank staff using principal component analysis on a range of PMIs for supply constraints in the manufacturing sector (supplier delivery times, stocks of purchases, stocks of finished goods, input prices and backlogs of work). Before principal components are estimated, these indicators are regressed on the new orders PMI to control for movements in demand. Latest data for the Global and China series are for March 2023, and April 2023 for the US and the euro-area series.

Headline inflation has been falling in the US and euro area…

Headline inflation has continued to decline in the euro area and the United States (Chart 2.4). In the euro area, HICP inflation had declined for five consecutive months to March, taking it to 6.9%, and the flash estimate for April was broadly unchanged at 7.0%. Energy price increases in the euro area last year were earlier than in the UK, and as a result, base effects have weighed on euro-area inflation earlier than in the UK. Base effects from energy prices will pull down UK CPI inflation in April (Section 2.4). In the US, headline PCE inflation, on which the Federal Reserve focuses, declined to 4.2% in March, from 5.1% in February. Recent falls have also been driven primarily by lower contributions from energy and core goods prices, with the contribution from energy turning negative in the latest release for the first time since early 2021. CPI inflation in the US has also been declining in recent months and stood at 5.0% in March.

Chart 2.4: Inflation has fallen in the US and euro area in recent months

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 March 2023 outturns.

…although core inflation has been slower to decline.

Core inflation, which excludes food and energy prices, has been more stable in the US and has risen in the euro area recently. Services inflation remains strong in both regions (Chart 2.4). As with UK services inflation (Section 3), this strength will partly reflect the indirect effects of higher input costs such as energy, particularly in the euro area. But given that wage bills are a large share of costs for service sector firms, another likely driver of services price inflation is the tightness of labour markets. Unemployment rates in the US and euro area are still very low by historical standards. Similarly, the ratio of vacancies to the number of unemployed people remains close to record highs in both economies. Wage growth in both regions has remained higher than respective pre-crisis averages, although it has been easing in the US.

Central banks have continued to tighten policy since the February Report…

In the US, the FOMC increased the target range for the federal funds rate by 25 basis points to 5.0%–5.25% at its meeting ending on 3 May, following a 25 basis point increase in March. At its meeting ending on 4 May, the ECB Governing Council raised its key policy rates by 25 basis points, which leaves the deposit rate at 3.25%. Both central banks stated that they would continue to judge the appropriateness of monetary policy depending on incoming data and its implications for the economic outlook.