Thursday, May 11, 2017

BOE holds policy but may tighten sooner than forecast

    The Bank of England (BOE) kept its key Bank Rate and stimulus measures unchanged but said monetary policy "could need to be tightened by a somewhat greater extent over the forecast period than the very gently rising path implied by the market yield curve underlying the May projections."
     Today's guidance is slightly more hawkish than in March when the BOE's Monetary Policy Committee (MPC) said "some modest withdrawal of monetary stimulus" may be appropriate.
      Kristin Forbes was once again the lone dissenting member of the MPC, voting to immediately raise the Bank Rate by 25 basis points to 0.25 percent, saying "inflation was already above the target, and pipeline pressures suggested it would continue to increase to uncomfortable levels and remain above the target for over three years," according to minutes from the meeting.
     In March Forbes, who is due to leave the MPC at the end of June, became the first member to vote for an increase since July 2016.
      But as in March, other members of the MPC are also leaning toward tighter policy, with the minutes saying it "would take relatively little further upside news on the prospects for activity or inflation for them to consider that a more immediate reduction in policy support might be warranted."
      At this month's meeting, there were only eight members of the MPC and not the usual nine as Deputy Governor Charlotte Hogg, who has resigned, has yet to be replaced.
     In addition to keeping the bank rate on hold, the MPC voted unanimously to maintain its stock of government bonds purchased at 435 billion pounds - known as quantitative easing - along with the 10 billion pound stock of corporate bonds that were purchased as part of a broad package of stimulus measures agreed in August last year as the BOE sought to shore up the economy after the Brexit vote.
      But growth in the UK has been stronger than the BOE feared last year, mainly due to higher-than-expected consumption as consumer drew down savings. But investment by businesses and in housing has also held up, the BOE said in its May inflation report.
     Compared with the August 2016 forecast, annual growth in the first quarter of this year is seen at 2.2 percent, 1.2 percentage points above it had expected.
     For the full year, UK Gross Domestic Product is now seen rising by 1.9 percent, down from the February forecast of 2.0 percent, then by 1.7 percent in 2018 and 1.8 percent in 2019.
   "In the MPC's central forecast, weaker consumption this year is largely balanced by rising net trade and investment," the BOE said.
     Employment is seen to be better than expected, with the unemployment rate now forecast at 4.7 percent in the second quarter of this year, down from February's forecast of 4.9 percent, then 4.7 percent in Q2 2018 compared with 5.0 percent, 4.6 percent in Q2 2019 and 4.5 percent in Q2 2020.
     The BOE projects the Bank Rate, based on market rates, will be raised to 0.3 percent by the second quarter of next year, a slight reduction from 0.4 percent projected in February, and then 0.4 percent in Q2 2019, down from 0.5 percent, and then 0.5 percent by Q2 2020.
     Due to the fall in the exchange rate of sterling in the wake of the vote to leave the European Union  (EU), known as Brexit, import prices have risen and thus pushed up overall inflation to above the BOE's 2.0 percent target.
     Inflation in the UK was steady at 2.3 percent in March and February but the BOE expects it to rise further in coming months to 2.7 percent in the second quarter, up from its previous forecast of 2.4 percent. In Q2 2018 inflation is seen at 2.6 percent, then 2.2 percent in Q2 2019 and 2.3 percent in the second quarter of 2020.

    The Bank of England issued the following statement:

"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 2017, the Committee voted by a majority of 7-1 to maintain Bank Rate at 0.25%. The Committee voted unanimously to maintain the stock of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, at £10 billion. The Committee also voted unanimously to maintain the stock of UK government bond purchases, financed by the issuance of central bank reserves, at £435 billion. 
As the MPC observed at the time of the United Kingdom’s referendum on EU membership, the appropriate path for monetary policy depends on the evolution of demand, potential supply, the exchange rate, and therefore inflation.  Aggregate demand slowed markedly in 2017 Q1, and the MPC’s central projection contained in the May Inflation Report is now for quarterly growth to remain around current rates, and close to trend.  The slowdown appears to be concentrated in consumer-facing sectors, partly reflecting the impact of sterling’s past depreciation on household income and spending.  The Committee judges that consumption growth will be slower in the near term than previously anticipated before recovering in the latter part of the forecast period as real income picks up.   
In the MPC’s central forecast, weaker consumption this year is largely balanced by rising net trade and investment.  The outlook for global activity continues to improve.  Business surveys and Bank Agents’ reports imply that business investment growth is likely to be higher in 2017 than previously projected.  The stronger global outlook and the level of sterling are providing incentives for many exporters to renew and increase capacity. 
Sterling appreciated by 2.5% between the February and May Inflation Reports, although it remained 16% below its November 2015 peak.  Over the same time period, shorter-term UK interest rates fell, with the sterling yield curve used to condition the forecast close to its lowest level since the start of the year.
CPI inflation has risen above the MPC’s 2% target as the depreciation of sterling has begun to feed through to consumer prices.  This impact has been offset to some extent by continued subdued growth in domestic costs.  In particular, wage growth has been notably weaker than expected.  The MPC expects inflation to rise further above the target in the coming months, peaking a little below 3% in the fourth quarter.  Conditioned on the market yield curve underlying the May projections, inflation is forecast to remain above the MPC’s target throughout the forecast period.  The projected overshoot entirely reflects the effects of the falls in sterling since late November 2015 on import prices.  This effect is expected to diminish towards the end of the forecast period.  With unemployment falling to its estimated equilibrium rate, however, wage growth is expected to recover significantly, and the drag from domestic costs to lessen, over the same period.  
Monetary policy cannot prevent either the necessary real adjustment as the United Kingdom moves towards its new international trading arrangements or the weaker real income growth that is likely to accompany that adjustment over the next few years.  Attempting to offset fully the effect of weaker sterling on inflation would be achievable only at the cost of higher unemployment and, in all likelihood, even weaker income growth.  For this reason, the MPC’s remit specifies that, in such exceptional circumstances, the Committee must balance any trade-off between the speed at which it intends to return inflation sustainably to the target and the support that monetary policy provides to jobs and activity.
In the MPC’s latest projections there is such a trade-off through most of the forecast period, with a degree of spare capacity and inflation remaining above the 2% target.  In the final year of the forecast, however, the output gap closes and inflation rises slightly further above the target.  This is conditioned on the assumptions that the adjustment to the United Kingdom’s new relationship with the European Union is smooth, and that Bank Rate follows the market-implied path for interest rates.  At its May meeting, seven members thought that the current monetary policy setting remained appropriate to balance the demands of the Committee’s remit.  Kristin Forbes considered it appropriate to increase Bank Rate by 25 basis points. 
As the Committee has previously noted, there are limits to the extent to which above-target inflation can be tolerated.  The continuing suitability of the current policy stance depends on the trade-off between above-target inflation and slack in the economy, as well as the prospects for inflation to return sustainably to target.  These projections depend importantly on three main judgements:  that the lower level of sterling continues to boost consumer prices broadly as projected, and without adverse consequences for inflation expectations further ahead;  that regular pay growth remains modest in the near term but picks up significantly over the forecast period;  and that more subdued household spending growth is largely balanced by a pickup in other components of demand.  
In judging the appropriate policy stance, the Committee will be monitoring closely the incoming evidence regarding these and other factors.  Monetary policy can respond in either direction to changes to the economic outlook as they unfold to ensure a sustainable return of inflation to the 2% target.  On the whole, the Committee judges that, if the economy follows a path broadly consistent with the May central projection, then monetary policy could need to be tightened by a somewhat greater extent over the forecast period than the very gently rising path implied by the market yield curve underlying the May projections. "


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