Thursday, February 8, 2018

UK central bank holds rate but sees earlier tightening

      The U.K. central bank left its benchmark Bank Rate at 0.50 percent, along with its stock of assets, unchanged but expects to tighten its monetary policy stance "somewhat earlier and by a somewhat greater extent" than earlier expected to rein in inflation as the economy continues to improve.
       The Bank of England (BOE), which already raised its rate by 25 basis points in November last year, raised its forecast for economic growth in the first quarter of this year to 1.7 percent from 1.5 percent forecast in November and the forecast for Q1 2019 to 1.8 percent from 1.7 percent.
       Although the BOE acknowledged that such growth rates are "modest" by historical standards, it exceeds the rate of supply that has been worsened by uncertainty over the U.K. future relationship with the European Union (EU), reducing the slack in the economy and pushing up wages.
       BOE estimates the UK economy has only "a very limited degree of slack" and capacity will only grow around 1.5 percent a year, reflecting lower growth in labour supply and productivity that is around half of its pre-crises average.
       "As growth in demand outpaces that of supply, a small margin of excess demand emerges by early 2020 and builds thereafter," the BOE said.
       Inflation in the U.K. has exceeded the BOE's 2.0 percent target since February 2017 but eased slightly to 3.0 percent in December from 3.1 percent in November.
        The BOE expects inflation to remain around 3.0 percent in the short term due to higher oil prices and the past effects of the fall in the pound's exchange rate that pushed up import prices.
        But while the effect of higher oil prices and sterling's decline slowly dissipate, the BOE expects domestic inflationary pressures to rise as pay growth rises in response to tighter labour markets.
        In the medium term, inflation is expected to remain above the 2.0 percent target.
        In its latest inflation report, the BOE raised its forecast for consumer price inflation to 2.9 percent for the first quarter of this year, up from 2.6 percent, while the outlook for first quarter 2019 inflation was unchanged at 2.3 percent.
        The forecast for the Bank Rate - based on forward market interest rates - was unchanged at 0.5 percent and 0.8 percent for the first quarters of this year and 2019, respectively. But for the first quarter of 2020 the forecast was raised to 1.0 percent from a previous 0.9 percent. For Q1 2021 the Bank Rate is seen at 1.2 percent.
        As in December, the BOE's monetary policy committee was unanimous in today's policy decision, reiterating that future rate increases are expected to be at "a gradual pace and to a limited extent."
        The slightly more hawkish stance by the BOE pushed up sterling against the U.S. dollar to above 1.40 from around 1.38 earlier today, continuing sterling's rise over the last 12 months from around 1.20.

       The Bank of England released the following 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 7 February 2018, the MPC voted unanimously to maintain Bank Rate at 0.5%. 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.

The MPC’s latest projections for output and inflation are set out in detail in the accompanying February Inflation Report. The global economy is growing at its fastest pace in seven years. The expansion is becoming increasingly broad-based and investment driven. Notwithstanding recent volatility in financial markets, global financial conditions remain supportive. UK net trade is benefiting from robust global demand and the past depreciation of sterling. Along with high rates of profitability, the low cost of capital and limited spare capacity, strong global activity is supporting business investment, although it remains restrained by Brexit-related uncertainties. Household consumption growth is expected to remain relatively subdued, reflecting weak real income growth. GDP growth is expected to average around 13⁄4% over the forecast, a slightly faster pace than was projected in November despite the updated projections being conditioned on the higher market-implied path for interest rates and stronger exchange rate prevailing in financial markets at the time of the forecast.

While modest by historical standards, that rate of growth is still expected to exceed the diminished rate of supply growth. Following its annual assessment of the supply side of the economy, the MPC judges that the UK economy has only a very limited degree of slack and that its supply capacity will grow only modestly over the forecast, averaging around 11⁄2% per year. This reflects lower growth in labour supply and rates of productivity growth that are around half of their pre-crisis average. As growth in demand outpaces that of supply, a small margin of excess demand emerges by early 2020 and builds thereafter.

CPI inflation fell from 3.1% in November to 3.0% in December. Inflation is expected to remain around 3% in the short term, reflecting recent higher oil prices. More generally, sustained above-target inflation remains almost entirely due to the effects of higher import prices following sterling’s past depreciation. These external forces slowly dissipate over the forecast, while domestic inflationary pressures are expected to rise. The firming of shorter-term measures of wage growth in recent quarters, and a range of survey indicators that suggests pay growth will rise further in response to the tightening labour market, give increasing confidence that growth in wages and unit labour costs will pick up to target-consistent rates. On balance, CPI inflation is projected to fall back gradually over the forecast but remain above the 2% target in the second and third years of the MPC’s central projection.

As in previous Reports, the MPC’s projections are conditioned on the average of a range of possible outcomes for the United Kingdom’s eventual trading relationship with the European Union. The projections also assume that, in the interim, households and companies base their decisions on the expectation of a smooth adjustment to that new trading relationship. Developments regarding the United Kingdom’s withdrawal from the European Union – and in particular the reaction of households, businesses and asset prices to them – remain the most significant influence on, and source of uncertainty about, the economic outlook. In such exceptional circumstances, the MPC’s remit specifies that 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.

Over the past year, a steady absorption of slack has reduced the degree to which it was appropriate for the MPC to accommodate an extended period of inflation above the target. Consequently, at its November 2017 meeting, the Committee tightened modestly the stance of monetary policy in order to return inflation sustainably to the target.

Since November, the prospect of a greater degree of excess demand over the forecast period and the expectation that inflation would remain above the target have further diminished the trade-off that the MPC is required to balance. It is therefore appropriate to set monetary policy so that inflation returns sustainably to its target at a more conventional horizon. The Committee judges that, were the economy to evolve broadly in line with the February Inflation Report projections, monetary policy would need to be tightened somewhat earlier and by a somewhat greater extent over the forecast period than anticipated at the time of the November Report, in order to return inflation sustainably to the target.

In light of these considerations, all members thought that the current policy stance remained appropriate to balance the demands of the MPC’s remit. Any future increases in Bank Rate are expected to be at a gradual pace and to a limited extent. The Committee will monitor closely the incoming evidence on the evolving economic outlook, and stands ready to respond to developments as they unfold to ensure a sustainable return of inflation to the 2% target.


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