Covid-19 (Covid) and the actions taken to contain it have continued to have a dramatic and rapidly changing impact on the United Kingdom and countries around the world. The Committee’s updated projections for economic activity and inflation are set out in the accompanying May Monetary Policy Report.
Global GDP growth is likely to have slowed in 2021 Q1 as Covid-related restrictions weighed on economic activity, although growth appears to have been stronger than expected in the February Report. Covid vaccination programmes have progressed and picked up pace in many countries. Recently, however, new Covid cases have increased significantly in India and some other economies, leading to tighter restrictions. Advanced-economy risky asset prices have continued to increase and longer-term government bond yields have stabilised since March, such that they are higher than at the time of the February Report.
UK GDP is expected to have fallen by around 1½% in 2021 Q1, less weak than was assumed in the February Report. New Covid cases in the United Kingdom have continued to fall, the vaccination programme is proceeding apace, and restrictions on economic activity are easing. Reflecting these developments, GDP is expected to rise sharply in 2021 Q2, although activity in that quarter is likely to remain on average around 5% below its level in 2019 Q4. GDP is expected to recover strongly to pre-Covid levels over the remainder of this year in the absence of most restrictions on domestic economic activity. Demand growth is further boosted by a decline in health risks and a fall in uncertainty, as well as announced fiscal and monetary stimulus. Consumer spending is also supported by households running down over the next three years around 10% of their additional accumulated savings. After 2021, the pace of GDP growth is expected to slow as the boost from some of those factors wanes. The level of activity is higher in each quarter of the forecast than in the February projections.
The fall in activity over the past year has reflected a decline in both demand and supply. The LFS unemployment rate fell slightly to 4.9% in the three months to February, but it is likely that labour market slack has remained higher than implied by this measure. Overall, there is judged to be spare capacity in the economy at present. The extension of the Government’s employment support schemes in Budget 2021 is expected to limit significantly the near-term rise in the LFS unemployment rate. The MPC also expects the medium-term equilibrium rate of unemployment to rise by less than was forecast in February. Spare capacity is eliminated as activity picks up during 2021, and there is a temporary period of excess demand, before demand and supply return broadly to balance.
Twelve-month CPI inflation rose from 0.4% in February to 0.7% in March, with the February outturn triggering the exchange of open letters between the Governor and the Chancellor published alongside this monetary policy announcement. The weakness of recent CPI outturns has largely reflected the direct and indirect effects of Covid on the economy. As has been the case in recent MPC forecasts, inflation is projected to rise to close to the target in the near term as some of those effects fade. In the central projection, CPI inflation rises temporarily above the 2% target towards the end of 2021, owing mainly to developments in energy prices. These transitory developments should have few direct implications for inflation over the medium term, however. In the central projection, conditioned on the market path for interest rates, inflation returns to around 2% in the medium term.
The outlook for the economy, and particularly the relative movement in demand and supply, remains uncertain. It continues to depend on the evolution of the pandemic, measures taken to protect public health, and how households, businesses and financial markets respond to these developments.
In the central projections of the MPC’s May Report, the economy experiences a temporary period of strong GDP growth and a temporary period of modestly above-target CPI inflation, after which growth and inflation fall back, with inflation around the target two and three years ahead. In judging the appropriate stance of monetary policy, the Committee will, consistent with its policy guidance and as always, focus on the medium-term prospects for inflation, including the balance between demand and supply, rather than factors that are likely to be transient.
The MPC will continue to monitor the situation closely and will take whatever action is necessary to achieve its remit. The Committee does not intend to tighten monetary policy at least until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably.
At this meeting, the Committee judged that the existing stance of monetary policy remained appropriate.