Monetary Policy Report - February 2024

Our quarterly Monetary Policy Report sets out the economic analysis and inflation projections that the Monetary Policy Committee uses to make its interest rate decisions.

We have kept interest rates at 5.25%

Published on 01 February 2024

We have raised over the past two years to help slow down price rises (). It’s working. Inflation in the UK has fallen from a peak of 11% in 2022 to 4% in December 2023. 

But inflation is still above our 2% target. High inflation affects everyone, but it particularly hurts those who can least afford it. We need to make sure it comes down further.

We expect inflation to fall, though with some bumps along the way. It could briefly drop to 2% in the spring, before increasing slightly again. 

We will keep interest rates high for long enough to get inflation back to the 2% target in a lasting way.

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Higher rates are working to reduce inflation.

Our job is to make sure that inflation returns to our 2% target.

Higher interest rates ensure inflation comes down and stays down.

We’ve been using higher interest rates for the past two years to help slow down price rises. We have, again, decided to hold interest rates at 5.25% at this meeting. 

Higher interest rates make it more expensive for people to borrow money and encourages them to save. That means that, overall, they will tend to spend less. If people on the whole spend less on goods and services, prices will tend to rise more slowly. That lowers the rate of inflation. 

We know that many people are facing higher borrowing costs. 

But high inflation that lasts for a long time makes things worse for everyone.

Higher interest rates are helping to bring inflation down. 

We have kept interest rates at 5.25% to help inflation return to our 2% target

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Inflation could fall to our 2% target within a few months, before rising slightly again.

The speed of price rises (inflation) is slowing. 

Inflation has fallen from a peak of 11% in 2022 to 4% in December 2023. Petrol and utility prices have fallen over the past year, and some other prices are now rising much more slowly, including food prices.

We expect inflation to fall further by the end of this year to around 2¾%.

But there could be some bumps along the way between now and then. 

Lower oil and gas prices could mean that inflation temporarily drops to 2% for a brief period, only to rise later in the year. 

We can’t rule out another global shock that keeps inflation high though.

Inflation has fallen

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We will keep interest rates high for long enough, so inflation settles at 2%.

We are focused on bringing inflation back down to our 2% target and keeping it there. 

We will keep interest rates high for long enough to ensure that we achieve our goal. 

High inflation affects everyone, but it particularly hurts those who can least afford it.

We expect inflation to fall further this year and next

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Monetary Policy Report

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 31 January 2024, the MPC voted by a majority of 6–3 to maintain Bank Rate at 5.25%. Two members preferred to increase Bank Rate by 0.25 percentage points, to 5.5%. One member preferred to reduce Bank Rate by 0.25 percentage points, to 5%.

The Committee’s updated projections for activity and inflation are set out in the accompanying February Monetary Policy Report. These are conditioned on a market-implied path for Bank Rate that declines from 5¼% to around 3¼% by the end of the forecast period, almost 1 percentage point lower on average than in the November Report.

Since the MPC’s previous meeting, global GDP growth has remained subdued, although activity continues to be stronger in the United States. Inflationary pressures are abating across the euro area and United States. Wholesale energy prices have fallen significantly. Material risks remain from developments in the Middle East and from disruption to shipping through the Red Sea.

Following recent weakness, GDP growth is expected to pick up gradually during the forecast period, in large part reflecting a waning drag on the rate of growth from past increases in Bank Rate. Business surveys are consistent with an improving outlook for activity in the near term.

The labour market has continued to ease, but remains tight by historical standards. In the February Report projections, the continuing relative weakness of demand, despite subdued supply growth by historical standards, leads a margin of economic slack to emerge during the first half of the forecast period. Unemployment is expected to rise somewhat further.

Twelve-month CPI inflation fell to 4.0% in December 2023, below expectations in the November Report. This downside news has been broad-based, reflecting lower fuel, core goods and services price inflation. Although still elevated, wage growth has eased across a number of measures and is projected to decline further in coming quarters.

CPI inflation is projected to fall temporarily to the 2% target in 2024 Q2 before increasing again in Q3 and Q4. This profile of inflation over the second half of the year is accounted for by developments in the direct energy price contribution to 12-month inflation, which becomes less negative. In the MPC’s latest most likely, or modal, projection conditioned on the lower market-implied path for Bank Rate, CPI inflation is around 2¾% by the end of this year. It then remains above target over nearly all of the remainder of the forecast period. This reflects the persistence of domestic inflationary pressures, despite an increasing degree of slack in the economy. CPI inflation is projected to be 2.3% in two years’ time and 1.9% in three years.

The Committee judges that the risks around its modal CPI inflation projection are skewed to the upside over the first half of the forecast period, stemming from geopolitical factors. It now judges that the risks from domestic price and wage pressures are more evenly balanced, meaning that, unlike in previous forecasts, there is no difference between the MPC’s modal and mean projections at the two and three-year horizons.

Conditioned on the alternative assumption of constant interest rates at 5.25%, the path for CPI inflation is significantly lower than in the Committee’s modal projection conditioned on the declining path of market rates, falling below the 2% target from 2025 Q4 onwards.

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. Monetary policy will ensure that CPI inflation returns to the 2% target sustainably in the medium term.

At this meeting, the Committee voted to maintain Bank Rate at 5.25%. Headline CPI inflation has fallen back relatively sharply. The restrictive stance of monetary policy is weighing on activity in the real economy and is leading to a looser labour market. In the Committee’s February forecast, the risks to inflation are more balanced. Although services price inflation and wage growth have fallen by somewhat more than expected, key indicators of inflation persistence remain elevated.

As a result, monetary policy will need to remain restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term in line with the MPC’s remit. The Committee has judged since last autumn that monetary policy needs to be restrictive for an extended period of time until the risk of inflation becoming embedded above the 2% target dissipates.

The MPC remains prepared to adjust monetary policy as warranted by economic data to return inflation to the 2% target sustainably. It will therefore continue to monitor closely indications of persistent inflationary pressures and resilience in the economy as a whole, including a range of measures of the underlying tightness of labour market conditions, wage growth and services price inflation. On that basis, the Committee will keep under review for how long Bank Rate should be maintained at its current level.

1: The economic outlook

Twelve-month CPI inflation remains above the MPC’s 2% target but declined to 4.2% in 2023 Q4. This was below expectations in the November Report, with broad-based downside news in the contributions from fuel, core goods and services prices. CPI inflation is now projected to fall temporarily to the 2% target in 2024 Q2 before increasing again in Q3 and Q4. This profile of inflation over the second half of the year is accounted for by developments in the direct energy price contribution to 12-month inflation, which becomes less negative. CPI inflation excluding energy is projected to remain above the target throughout this period, at around 3% (Chart 1.1). Annual private sector regular average weekly earnings (AWE) growth declined to 6.5% in the three months to November, around 1 percentage point below the expectation in the November Report. This has brought the AWE measure back into line with the steer from other indicators of annual pay growth. The near-term outlook for pay growth is weaker than projected in November, but it remains elevated.

The Committee continues to expect second-round effects in domestic prices and wages to take longer to unwind than they did to emerge (Key judgement 3). In the MPC’s modal, or most likely, projection conditioned on the lower market-implied path of interest rates, CPI inflation is around 2¾% at the end of this year. It then remains above target over nearly all of the remainder of the forecast period. This reflects the persistence of domestic inflationary pressures, despite an increasing degree of slack in the economy. CPI inflation is projected to be 2.3% in two years’ time and 1.9% in three years (Table 1.A). The Committee judges that the risks around its modal CPI inflation projection from domestic price and wage pressures are now more evenly balanced. There are, however, some upside risks to the modal projection from geopolitical factors over the first half of the forecast period.

Following recent weakness, GDP growth is expected to pick up gradually during the forecast period (Key judgement 1). That in large part reflects a waning drag on the rate of growth from past increases in Bank Rate. Excess demand in the UK economy is judged to have diminished significantly over recent quarters. Potential supply growth is expected to remain relatively subdued by historical standards (Section 3), but the continuing relative weakness of demand leads a margin of economic slack to emerge during the first half of the forecast period (Key judgement 2). Unemployment is expected to rise somewhat further.

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

2024 Q1

2025 Q1

2026 Q1

2027 Q1

GDP (c)

0.0 (0.2)

0.5 (0.0)

0.8 (0.6)

1.5

Modal CPI inflation (d)

3.6 (4.4)

2.8 (2.5)

2.3 (1.9)

1.9

Mean CPI inflation (d)

3.7 (4.4)

3.0 (2.8)

2.3 (2.2)

1.9

Unemployment rate (e)

4.4 (4.4)

4.7 (4.8)

4.9 (5.0)

4.9

Excess supply/Excess demand (f)

-¼ (-¼)

-½ (-1)

-1 (-1½)

Bank Rate (g)

5.1 (5.3)

3.9 (5.0)

3.3 (4.4)

3.2

Footnotes

  • (a) Figures in parentheses show the corresponding projections in the November 2023 Monetary Policy Report.
  • (b) Unless otherwise stated, the numbers shown in this table are modal projections and are conditioned on the assumptions described in Section 1.1. The main assumptions are set out in Monetary Policy Report – Download chart slides and data – February 2024.
  • (c) Four-quarter growth in real GDP.
  • (d) Four-quarter inflation rate. The modal projection is the single most likely outcome. If the risks are symmetrically distributed around this central view, this will also provide a view of the average outcome or mean forecast. But when the risks are skewed, as in the current forecast, the mean projection will differ from the mode.
  • (e) ILO definition of unemployment. Up to June 2023, this projection is based on LFS unemployment data. Beyond this point, the Committee is drawing on the collective steer from other indicators of unemployment to inform its projection (see Box B in the November 2023 Monetary Policy Report).
  • (f) Per cent of potential GDP. A negative figure implies output is below potential and a positive that it is above.
  • (g) Per cent. The path for Bank Rate implied by forward market interest rates. The curves are based on overnight index swap rates.

Chart 1.1: CPI inflation and CPI inflation excluding energy (a)

Energy prices are expected to reduce inflation in early 2024 but that drag is waning, leading to a rise in inflation.

Footnotes

  • Sources: Bloomberg Finance L.P., ONS and Bank calculations.
  • (a) Energy prices include fuels and lubricants, electricity, gas and other fuels.

1.1: The conditioning assumptions underlying the MPC’s projections

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

  • The lower paths for policy rates in advanced economies implied by financial markets, as captured in the 15-working day averages of forward interest rates to 23 January (Chart 2.5). The market-implied path for Bank Rate in the United Kingdom has fallen by almost 1 percentage point on average over the next three years compared with the equivalent period at the time of the November Report. The path for Bank Rate underpinning the February projections declines from 5¼% to around 3¼% by the end of the forecast period.
  • A path for the sterling effective exchange rate index that is over 2% higher on average than in the November Report. The exchange rate depreciates slightly over the forecast period, reflecting the role for expected interest rate differentials in the Committee’s conditioning assumption.
  • Wholesale energy prices that follow their respective futures curves over the forecast period. Since November, oil and gas prices have declined materially (Chart 2.3), despite the recent disruptions to shipping in the Red Sea. Significant uncertainty remains around the outlook for wholesale energy prices, including related to recent geopolitical developments (Key judgement 3).
  • UK household energy prices that move in line with Bank staff estimates of the Ofgem price cap implied by the path of wholesale energy prices (Section 2.3).
  • Fiscal policy that evolves in line with announced UK government policies to date. As discussed in Box A, additional fiscal measures were announced in the Autumn Statement, including a two pence cut in the main rate of employee National Insurance contributions, a permanent 100% capital allowance for qualifying business investment, and a package of reforms to welfare and health services designed to increase labour market participation.
  • The variant of the ONS’s 2020-based population projections, published in January 2023, which reflects international migration to the year ending June 2022 (Section 3).

Table 1.B: Conditioning assumptions (a) (b)

Average 1998–2007

Average 2010–19

2022

2023

2024

2025

2026

Bank Rate (c)

5.0

0.5

2.8

5.2 (5.3)

4.2 (5.1)

3.4 (4.5)

3.2 (4.2)

Sterling effective exchange rate (d)

100

82

78

81 (81)

82 (80)

81 (80)

81 (79)

Oil prices (e)

39

77

89

84 (90)

76 (81)

73 (77)

71 (74)

Gas prices (f)

29

52

201

101 (118)

88 (142)

87 (117)

82 (99)

Nominal government expenditure (g)

4

6¾ (6¼)

3 (¾)

2 (1¾)

2¾ (2½)

Footnotes

  • Sources: Bank of England, Bloomberg Finance L.P., Office for Budget Responsibility (OBR), ONS, Refinitiv Eikon from LSEG and Bank calculations.
  • (a) The table shows the projections for financial market prices, wholesale energy prices and government spending projections that are used as conditioning assumptions for the MPC’s projections for CPI inflation, GDP growth and the unemployment rate. Figures in parentheses show the corresponding projections in the November 2023 Report.
  • (b) Financial market data are based on averages in the 15 working days to 23 January 2024. Figures show the average level in Q4 of each year, unless otherwise stated.
  • (c) Per cent. The path for Bank Rate implied by forward market interest rates. The curves are based on overnight index swap rates.
  • (d) Index. January 2005 = 100. The convention is that the sterling exchange rate follows a path that is halfway between the starting level of the sterling ERI and a path implied by interest rate differentials.
  • (e) Dollars per barrel. Projection based on monthly Brent futures prices.
  • (f) Pence per therm. Projection based on monthly natural gas futures prices.
  • (g) Annual average growth rate. Nominal general government consumption and investment. Projections are based on the OBR's November 2023 Economic and Fiscal Outlook. Historical data based on NMRP+D7QK.

1.2: Key judgements and risks

1.2: Key judgement 1

Following recent weakness, GDP growth is expected to pick up gradually during the forecast period. That in large part reflects a waning drag on the rate of growth from past increases in Bank Rate.

UK GDP is expected to have been flat in 2023 Q4. Combined with downward revisions to previous quarters, the level of GDP starts the forecast period around ½% lower than expected at the time of the November Report. Market sector output, which is less subject to swings in measured non-market output such as in the health and education sectors, is now expected to have declined by around ¼% in both 2023 Q3 and Q4. Private final domestic demand including household consumption has also been weak (Section 2.2).

GDP is projected to increase by 0.1% in 2024 Q1 and at a similar pace over the following few quarters, slightly stronger rates than expected in the November Report. Business surveys, such as the S&P Global/CIPS UK composite PMI, suggest that private sector activity has stabilised and may be edging up again.

Based on the average relationships over the past between Bank Rate, other financial instruments and economic activity, and taking account of recent declines in market interest rates, Bank staff estimate that around two thirds of the peak domestic impact of higher interest rates on the level of GDP has come through. There remains significant uncertainty around that estimate, however. In particular, recent developments suggest that house prices have held up to a greater extent than might otherwise have been expected (Chart 2.11), and that the collateral and precautionary savings channels of monetary policy through which house prices affect consumer spending could be somewhat weaker than expected over coming quarters.

Taken together, the pass-through of past rises in interest rates and the latest market-implied interest rate path on which the forecast is conditioned (Section 1.1) continue to push down on the level of GDP over the first half of the forecast period in absolute terms. There is nevertheless a waning drag on the rate of GDP growth from monetary policy. Compared with the November projection, the fall in the market path over recent months pushes up on GDP materially throughout this forecast, all else equal.

As discussed in Box A, the combined effect of the policies announced in the Autumn Statement is expected to boost the level of aggregate demand by around 0.2% in fiscal years 2024–25 and 2025–26, and by around 0.3% in 2026–27, relative to the November Report projections. As these measures are also likely to boost potential supply to some extent, including through higher labour market participation, the implications for the MPC’s output gap projection (Key judgement 2), and hence inflationary pressures in the economy, are projected to be smaller.

After taking account of all announced government plans, the positive impacts on the level of GDP of past fiscal loosening measures, including those related to the pandemic and the energy price shock, continue to unwind. This pulls down on the Committee’s GDP growth projection during the forecast period. Measured real government consumption is nevertheless expected to grow quite strongly in 2024, by 4%, before growth slows over the forecast period.

Relative to the November Report, the recent fall in wholesale, and prospective household and business, energy prices boosts UK GDP somewhat. Set against that, there are risks to energy prices and other global trade flows from an escalation of recent disruption in the Red Sea and from related geopolitical developments. The Committee’s February central projection assumes that half of the total trade flowing through the Red Sea is disrupted during the first half of this year, with much of it being diverted via longer routes. This equates to a relatively small effect on UK and global trade volumes, all else equal.

International GDP growth has continued to be subdued (Section 2.1). The path of global GDP is expected to be slightly higher than in the November Report over much of the forecast period, in part reflecting looser global financial conditions. In the MPC’s February projection, annual UK-weighted world GDP growth is projected to rise in the medium term, to slightly below its average rate in the decade prior to the pandemic (Table 1.D).

Growth among advanced economies diverged in 2023, with significantly stronger growth in the United States than in the euro area. In light of recent developments, Bank staff have revised up their view of the supply potential of the US economy, reflecting a higher projected population, and higher structural labour participation and productivity assumptions. Alongside other factors, this pushes up on the US GDP growth projection relative to the November Report. Bank staff judge that euro-area supply growth will remain more subdued than in the United States and grow at a similar pace over the forecast period to UK supply growth (Key judgement 2).

Overall, in the Committee’s February projection, UK GDP growth is projected to pick up gradually during the forecast period. That in large part reflects a waning drag on the rate of growth from past increases in Bank Rate. The impact of fiscal policy and relatively weak potential supply growth (Key judgement 2) pull down on GDP growth throughout the forecast period relative to historical averages. Four-quarter GDP growth recovers to 1½% by the end of the forecast period (Chart 1.2). Relative to the November Report projection, and despite a weaker starting point for activity, the level of GDP has been revised up by just under ¾% by the end of the forecast period, more than accounted for by the boost to activity from the recent lower path of market interest rates on which the forecast is conditioned.

Within the key domestic expenditure components underpinning the February GDP projection conditioned on market interest rates (Table 1.D), household spending is expected to decline by ¼% this year, although this reflects the effect on the annual average of declines in consumption in 2023. The level of household spending is expected to be flat in 2024 H1 and to pick up over the remainder of the forecast period. Taking account of all components of household income, the saving ratio is expected to remain elevated this year before falling back over the remainder of the forecast period. In large part reflecting the transmission of higher interest rates, housing investment is expected to continue to fall in the near term (Section 2.2), before picking up slightly over the remainder of the forecast period. Business investment is projected to be flat over the first half of the forecast period, but to pick up slightly thereafter (Section 3). Weakness in near-term private final domestic demand growth is expected to be offset by strong real government consumption growth.

Chart 1.2: GDP growth projection based on market interest rate expectations, other policy measures as announced

Shaded fan chart for the four-quarter G D P growth projection (wide bands). There is uncertainty around the O N S data, because they may be revised over time. The distribution widens over the forecast period to reflect uncertainty around the outlook for G D P.

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. The y-axis of the chart has been truncated to illustrate more clearly the current uncertainty around the path of GDP growth, as otherwise this would be obscured by the volatility of GDP growth during the pandemic.

In the GDP projection conditioned on the alternative assumption of constant interest rates at 5.25% over the forecast period, growth is significantly weaker over the forecast period compared with the MPC’s projection conditioned on the declining path of market-implied rates.

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

There are risks in both directions around the central projections for domestic spending and GDP, including those related to the transmission of monetary policy. In particular, there is uncertainty around the collateral and precautionary savings channels through which house prices affect consumer spending, and around the extent to which the full effects of interest rates on business investment have already come through. The Committee will continue to monitor closely the impact of the significant increase in Bank Rate. It will also continue to keep under review the relationship between Bank Rate and economic activity, including how it may have changed during the current tightening cycle.

Internationally, the risk of higher commodity prices and disruption to trade flows could lead to weaker economic activity as well as greater external inflationary pressures (Key judgement 3).

1.2: Key judgement 2

Excess demand in the UK economy is judged to have diminished significantly over recent quarters. Potential supply growth is expected to remain relatively subdued by historical standards, but the continuing relative weakness of demand leads a margin of economic slack to emerge during the first half of the forecast period. Unemployment is expected to rise somewhat further.

Potential supply determines the level of output the economy can sustain without generating excessive inflationary pressures. Since the previous Report, the Committee has concluded its supply stocktake (Section 3), which has fed into the construction of its latest projections.

The Committee has reviewed its assessment of the past and current degree of economic slack. Taking a steer from a number of estimates, which take some signal from the strength of underlying inflationary pressures, the MPC judges that the degree of excess demand has been a little higher over the previous couple of years than was assumed in the November Report. As the level of actual output has also been lower than expected in November, this implies that potential supply has been even weaker.

In absolute terms, the margin of excess demand is now judged to have peaked at around 1¾% of potential GDP at the start of 2022, before declining steadily to around zero over the past two years. That period of excess demand has been accounted for by the tightness of the labour market and, initially, by a higher than normal degree of capacity utilisation within companies following the pandemic. Over the past year, businesses have responded to the weakness in demand by retaining their existing employees, while using them less intensively.

The MPC is continuing to consider the collective steer from a wide range of data to inform its view on labour market developments. As discussed in Box B in the November 2023 Report, there are increased uncertainties around the ONS’s official labour market activity data that have previously been based on the Labour Force Survey.

Alongside weakness in output, a range of indicators suggest that employment growth is likely to have slowed around the turn of the year but not turned negative (Chart 2.12). The ONS’s alternative experimental statistic for the unemployment rate has remained flat at 4.2% in the three months to November, having increased by 0.7 percentage points from its trough in 2022. And there has been other evidence of a loosening in the labour market, although it remains tight by historical standards.

As discussed in the November Report, the medium-term equilibrium rate of unemployment is judged to be around 4½% currently. Following a review during this supply stocktake, and despite some evidence of a decline over recent years in the efficiency with which vacancies are matched to those seeking work, the MPC continues to judge that the long-term equilibrium rate of unemployment, which the medium-term rate should converge back to over time, is just above 4%.

The MPC judged at the time of its previous stocktake that a constellation of major economic shocks was already weighing materially on the level of estimated potential supply and would continue to weigh on it over the forecast period (Key judgement 1 in the February 2023 Report). Since then, the MPC judges that the supply impacts from the change in the UK’s trading relationship with the EU are evolving broadly as expected (Section 3). But, alongside recent declines in commodity prices, new analysis of energy-intensive industries suggests that the risks of a persistent hit to supply from the global energy price shock have reduced. And the latest available data suggest that the Covid-related drag on potential participation may be unwinding faster than anticipated, while the lasting effects of the pandemic on potential productivity are also likely to be smaller than previously assumed.

Overall, in the MPC’s latest forecast conditioned on the ONS’s 2020-based population projections (Section 1.1), potential supply growth is expected to pick up to around 1¼% per year in 2025 and 2026 (Chart 3.1). This is somewhat weaker than the average growth rate in the decade before the pandemic and much lower than in the decade prior to the global financial crisis (GFC). But it is stronger than the projection for supply growth at the time of the previous stocktake in February 2023 and slightly above the projection in the November Report.

In the Committee’s latest projection, growth in potential productivity in 2025 and 2026 is expected to be around ¾% (Chart 3.5), slightly stronger than the average growth rate in the decade before the pandemic but much lower than in the decade prior to the GFC. Despite the adverse impact of long-running demographic trends such as an ageing population, projected potential labour supply growth is expected to increase by around ½% per year over the forecast period, accounted for primarily by population growth.

Although potential supply growth is expected to be relatively subdued, particularly in the near term, the outlook for demand is weaker, leading to a margin of economic slack emerging in the Committee’s latest projections during the first half of the forecast period. Aggregate excess supply is expected to remain around 1% of potential GDP towards the end of the forecast period (Table 1.A), compared with around 1½% of GDP in the November Report. Relative to November, the projection for excess demand/supply has been pushed up by the boost to demand from the lower market path of interest rates, which more than offsets somewhat stronger expected potential supply growth.

In the MPC’s latest projection, the unemployment rate is projected to continue to rise gradually over much of the forecast period such that it exceeds the assumed medium-term equilibrium rate by the end of this year. The unemployment rate reaches around 5% by the end of the forecast period (Chart 1.3). This is a slightly lower path for unemployment than in the November Report.

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

Shaded fan chart for the unemployment rate projection. The distribution widens over the forecast period.

Footnotes

  • The fan chart depicts the probability of various future outcomes for the ILO definition of unemployment and begins in 2023 Q4. 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. Up to June 2023, this fan chart is based on LFS unemployment data. Beyond this point, the Committee is drawing on the collective steer from other indicators of unemployment to inform its projection (see Box B in the November 2023 Report). 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 5.25% over the forecast period, the unemployment rate rises to a significantly greater extent compared with the MPC’s projection conditioned on market rates.

There are risks in both directions around the projection for potential supply growth.

As discussed in Section 3, updated ONS population estimates and projections, which are yet to be incorporated in the MPC’s forecasts, imply a higher rate of recent and future labour supply growth. On 30 January, the ONS released an update showing a stronger profile for population growth than in its previous 2020-based projections. These updated population projections were not available in time to be reflected in the Committee’s latest supply-side assessment, but all else equal they may suggest a somewhat higher path of labour supply and potential output growth in the future. However, a higher future path for the population would generally have similar impacts on both supply and demand, and thus only a limited impact on inflationary pressure. For a given level of measured GDP, a larger working age population over the recent past also implies weaker labour productivity, and so could imply downside risks around future productivity growth all else equal.

There are other possible risks around the MPC’s projection for potential productivity and supply growth, which remain somewhat weaker than other external forecasters including the Office for Budget Responsibility, even after allowing for differences in population conditioning assumptions. Productivity growth could nevertheless be weaker than the Committee expects if, for example, there were to be fewer insolvencies of lower-productivity companies. As discussed in Section 3, innovations in artificial intelligence technologies are likely to bring about changes in the way some sectors operate, but the speed of take-up and implications for productivity are uncertain. If future supply growth is stronger than expected for this reason, the boost to expected incomes would also be likely to raise demand and, similar to the risks around population growth, the impact on the Committee’s inflation projection would be limited.

There remains significant uncertainty around the Committee’s assumptions for the paths of the medium and long-term equilibrium rates of unemployment, news in which would, holding demand fixed, have implications for labour market tightness and inflationary pressures.

1.2: Key judgement 3

The Committee continues to expect second-round effects in domestic prices and wages to take longer to unwind than they did to emerge. In the near term, CPI inflation falls more quickly than projected previously, partly reflecting lower energy prices. But, conditioned on the lower path of market interest rates, inflation then increases and remains above the 2% target over nearly all of the remainder of the forecast period, despite an increasing degree of slack in the economy.

Twelve-month CPI inflation remains above the MPC’s 2% target, but has fallen back to 4.2% in 2023 Q4 and was 4.0% in December, below expectations in the November Report. The downside news since the previous Report has been broad based, reflecting lower fuel, core goods and services inflation (Section 2.3).

CPI inflation is now projected to fall temporarily to the 2% target in 2024 Q2 before increasing slightly again in Q3 and in Q4. This profile of inflation over the second half of the year is accounted for by developments in the direct energy price contribution to 12-month inflation. Based on the latest paths of oil and gas futures prices, the direct energy contribution is lower during the first year of the forecast period than in the Committee’s previous forecast. But, in absolute terms, the direct energy contribution to CPI inflation becomes somewhat less negative in 2024 Q3 and Q4 compared with Q2 (Chart 1.1). CPI inflation excluding energy is projected to remain above the target throughout the second half of this year, and by more than headline inflation, at around 3%.

In the near term, inflation in prices of UK core consumer goods, and food and non-alcoholic beverages, are projected to continue to fall back, to just over zero by the middle of this year.

Four-quarter UK-weighted world export price inflation, excluding the direct effect of oil prices, is estimated to have been negative at the end of last year, but is now expected to pick up more quickly and be positive at the start of this year. This reflects recent strength in euro-area export price data, which is only partially offset by a weaker forecast for export prices in China. Over the forecast period, the recent appreciation of the sterling exchange rate and its assumed path (Section 1.1) will, however, put downward pressure on UK import price inflation, and over time on CPI inflation, relative to the November Report. Import prices are projected to fall by 1¾% in 2024, a smaller fall than expected in the November Report, but rise by ¾% in 2025 (Table 1.D).

The MPC is continuing to monitor closely indications of persistent inflationary pressures and resilience in the UK economy as a whole, including a range of measures of the underlying tightness of labour market conditions (Key judgement 2), wage growth and services price inflation.

Services CPI inflation has remained significantly elevated but has fallen back somewhat more quickly than expected. Median services inflation, which is less sensitive to changes in the inflation rate of individual services, has also started to decline in recent months (Chart 2.19). Services price inflation is expected to continue to ease over the course of this year, albeit more slowly than other components of the CPI basket.

Annual private sector regular AWE growth declined to 6.5% in the three months to November, around 1 percentage point below the expectation in the November Report. This has brought the AWE measure back into line with the steer from other indicators of annual pay growth, which lies between 6% and 7% (Chart 2.15).

Recent outturns in wage growth have also continued to be stronger than standard models of wage growth, based on productivity, short-term inflation expectations and a measure of economic slack, would have predicted (Chart 1.4). The MPC continues to judge that private sector regular AWE growth will ease more slowly than the range of forecasts from this suite of models would predict, consistent with its broader judgement that second-round effects in both domestic prices and wages will take longer to unwind than they did to emerge.

Overall, the near-term outlook for pay growth is weaker than projected in the November Report, with the annual growth rate of private sector regular AWE projected to decline to around 4¾% by 2024 Q2 and to end this year at a similar rate. However, this profile also reflects an MPC judgement to push up slightly on pay growth in the near term, in light of the stronger forward-looking indications from the Bank’s Agents pay settlements survey (Box D) and from the Decision Maker Panel Survey.

In the MPC’s February projection, private sector regular AWE growth falls to around 3% by the end of the forecast period (Chart 1.4), 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 (Key judgement 2). This is a similar medium-term profile for AWE growth compared to the November Report. Private sector regular pay-based unit wage cost growth is expected to fall back to 3¼% in 2024 and to 2% in 2025 (Table 1.D).

Chart 1.4: Projections for private sector regular average weekly earnings four-quarter growth (a)

Pay growth in the near term is above the swathe of suite models, but the gap closes during 2025.

Footnotes

  • Sources: Bloomberg Finance L.P., Citigroup, ONS, YouGov and Bank calculations.
  • (a) The shaded range represents a range of projections from three statistical models of nominal private sector regular average weekly earnings growth, including a wage equation based on Yellen (2017) as shown in Chart 2.16, a wage equation based on Haldane (2018) and a simple error-correction model based on productivity, inflation expectations and slack in the labour market as embodied in the difference between the actual unemployment rate and the Committee’s estimate of the medium-term equilibrium rate. The projections are dynamic, multi-step ahead forecasts beginning at a point within the models’ estimation periods and are sensitive to data revisions, which can lead to changes in the range over the past as well as over the forecast period.

In the MPC’s modal, or most likely, projection conditioned on the lower market-implied path of interest rates as captured in the 15-working day average to 23 January, CPI inflation increases from the 2% target in 2024 Q2 to around 2¾% at the end of this year. It then remains above target over nearly all of the remainder of the forecast period. This reflects the persistence of domestic inflationary pressures, despite an increasing degree of slack in the economy (Key judgement 2). CPI inflation is projected to be 2.3% in two years’ time and 1.9% in three years (Table 1.C and Chart 1.5).

Compared with the November Report, the CPI inflation projection is pushed up in the medium term by higher projected energy (Chart 1.1) and other import price inflation, and also by some reduction in the margin of slack projected to emerge in the economy conditioned on the latest market path of interest rates. Partially offsetting these effects, the Committee has unwound a small part of its previous judgement on the degree of persistence in domestic prices in this forecast.

Chart 1.5: CPI inflation projection based on market interest rate expectations, other policy measures as announced