Monetary policy summary
The Bank of England’s Monetary Policy Committee (MPC) sets monetary policy in order to meet the 2% inflation target and in a way that helps to sustain growth and employment. At its meeting ending on 6 October, the MPC voted by a majority of 8-1 to maintain Bank Rate at 0.5%. The Committee voted unanimously to maintain the stock of purchased assets financed by the issuance of central bank reserves at £375 billion.
Twelve-month CPI inflation was zero in August, well below the 2% target rate. Around three-quarters of that deviation reflects unusually low contributions from energy, food and other imported goods prices. The remaining quarter reflects the past weakness of domestic cost growth. Although rising, increases in labour costs remain lower than would be consistent with meeting the inflation target in the medium term, were they to persist at current rates. Core inflation remains subdued at around 1%, influenced both by restrained labour cost growth and by muted import cost growth, itself partly reflecting the continuing dampening influence of sterling’s appreciation since mid-2013.
With inflation below the target, and the likelihood that at least some spare capacity remains in the economy, the MPC intends to set monetary policy so as to ensure that growth is sufficient to absorb any remaining underutilised resources. That will support domestic cost growth and is necessary to ensure that inflation is on track to return sustainably to the 2% target rate within two years.
The Committee will set out its next detailed assessment of the outlook for the economy in the forthcoming November Inflation Report. As in recent months, the outlook for growth remains characterised by a number of opposing influences. On the one hand, UK private final domestic demand, and consumer spending in particular, has been resilient, buttressed by the recovery in real income growth and productivity, supportive monetary policy, and robust business and consumer confidence. On the other hand, the on-going fiscal consolidation has had a restraining influence on activity and global growth has continued at below-average rates. Similarly, after the direct effects of past movements in international energy and food prices have washed out of the annual comparison, the outlook for inflation in the medium term will reflect the balance of two opposing forces: the extent to which domestic costs pressures build, set against any persisting external disinflationary pressure.
The most recent official estimates and survey data are consistent with a gentle deceleration in UK output growth since its peak at the beginning of 2014. The sharp declines in the unemployment rate seen since the middle of 2013 now appear to have levelled off. Some slowdown in the pace of the expansion and employment growth had been expected by the MPC as a natural consequence of the economy approaching a balance between its supply capacity and strengthening demand following the United Kingdom’s gradual recovery from the financial crisis. Indeed, there is increasing evidence of developing capacity pressures in some segments of the economy, and of labour skill shortages in particular. Annual regular pay growth in the private sector has risen and now exceeds 3%. But encouraging improvements in productivity growth have so far limited the impact of that pickup in pay growth on businesses’ overall costs, and therefore inflation.
A deterioration in the global demand environment would slow the pace of expansion further. That could occur, for example, were the slowdown currently underway in a range of emerging economies, including China, to intensify. Growth in the euro area, the United Kingdom’s main trading partner, has so far remained relatively resilient. As always, the Committee will continue to monitor international developments, as well as evidence concerning the resilience of the domestic economy, to assess the outlook for inflation and activity in the United Kingdom, and set monetary policy as appropriate in the light of all of those factors.
There remains a range of views among MPC members about how each of the factors relevant for the outlook for inflation might evolve in future. At the Committee’s meeting ending on 6 October, the majority of members judged that the current stance of monetary policy remained appropriate. Ian McCafferty preferred to increase Bank Rate by 25 basis points, given his view that building domestic cost pressures were likely to come to outweigh the dampening influence of the appreciation of sterling, causing inflation to overshoot the 2% target in the medium term.
All members agreed that the likely persistence of the headwinds restraining economic growth following the financial crisis means that, when Bank Rate does begin to rise, it is expected to do so more gradually and to a lower level than in recent cycles. Such guidance, however, is an expectation and not a promise: the path that Bank Rate will actually follow over the next few years will depend on economic circumstances.