By CentralBankNews.info
The U.K. central bank left its benchmark Bank Rate unchanged at 0.75 percent, as expected, but said the direction of its monetary policy would depend on the nature of Britains’ exit from the European Union (EU) and the response “whatever form it takes, will not be automatic and could be in either direction.”
The Bank of England (BOE), which has raised its rate twice since August 2016 when the rate was cut in response to the decision to withdraw from the EU, added the economic outlook would depend significantly on the nature of EU withdrawal and “the implications for the appropriate path of monetary policy will depend on the balance of the effects on demand, supply and the exchange rate.”
Despite the uncertainty facing BOE policy makers, the monetary policy committee (MPC) reiterated that if the economy develops broadly in line with its November projections, “an ongoing tightening of monetary policy over the forecast period would be appropriate to return inflation sustainable to the 2% target over a conventional horizon.”
In its latest inflation report, the BOE raised its forecast for inflation in the fourth quarter of 2018 to 2.5 percent from August’s forecast for 2.3 percent but lowered the forecast for inflation in the fourth quarter of 2019 to 2.1 percent from 2.2 percent.
For the last quarter of 2020 inflation is seen at 2.1 percent, up from 2.0 percent, and then at 2.0 percent in the fourth quarter of 2021.
A disruptive withdrawal from the EU is likely to lead to a sharp fall in pound sterling and higher tariffs, boosting inflation. Set against this, demand is likely to weaken, reflecting lost trade access heightened uncertainty and tighter financial conditions, the inflation report said.
Summarizing forward rates in financial markets, the Bank Rate is seen steady this year before rising to 1.0 percent in the fourth quarter of 2019 – implying one rate hike – then 1.2 percent in the fourth quarter of 2020, up from 1.1 percent forecast in August, and then 1.4 percent in the final quarter of 2021.
Under the assumption of a smooth adjustment to future trading relationship with the EU, Britain’s gross domestic product is seen growing an average of 1.75 percent through 2021, with the unemployment rate steady at 3.9 percent but excess demand slowly rising.
As in September, the BOE’s 9-member MPC was unanimous in its policy decision. Despite uncertainty over Brexit, the BOE raised its rate in November last year and then in August this year to counter inflationary pressures from the decline in the exchange rate of pound sterling.
Today the pound, which plunged in response to the EU referendum and has weakened this year, rose against the U.S. dollar and was trading at 1.295, but still down 4.2 percent this year.
“Momentum in household consumption appears greater than previously expected, supported by the strong labour market and resilient household confidence,” the BOE said, adding this contrasted with business investment that has been more subdued than anticipated “as the effect of Brexit uncertainty has intensified.”
Under the assumption of a smooth transition, BOE expects investment growth to bounce back in coming months as greater clarity over future trading conditions emerges.
The UK economy grew by an annual rate of 1.2 percent in the second quarter of this year, up from 1.1 percent in the first quarter while headline inflation eased to 2.4 percent in September from 2.7 percent in August.
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 31 October 2018, the MPC voted unanimously to maintain Bank Rate at 0.75%.
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 updated projections for inflation and activity are set out in the November Inflation Report. In the Committee’s central projection, conditioned on the gently rising path of Bank Rate implied by market yields and on a smooth adjustment to the average of a range of possible outcomes for the United Kingdom’s eventual trading relationship with the European Union, GDP is expected to grow by around 1¾% per year on average over the forecast period. Momentum in household consumption appears greater than previously expected, supported by the strong labour market and resilient household confidence. Over the forecast period, household consumption is expected to grow modestly relative to historical rates, broadly in line with real incomes. In contrast, business investment has been more subdued than previously anticipated, as the effect of Brexit uncertainty has intensified. Under the smooth transition assumption on which the forecast is conditioned, greater clarity is expected to emerge over the coming months, boosting investment growth. The MPC’s projections were finalised before the Budget measures had been announced and the Committee will assess the implications at its next meeting.
The global economy continues to grow at above potential rates, supporting UK net trade. Growth has softened, however, and become more uneven across countries, and downside risks have risen. Global financial conditions have tightened, particularly in emerging market economies, and activity has slowed in the euro area. Trade restrictions have increased and there is a risk of further escalation.
The MPC judges that aggregate supply and demand are now broadly in balance. The labour market remains tight, with the employment rate and vacancies around record highs, and the unemployment rate at its lowest since the mid-1970s. Regular pay growth has been stronger than expected, rising to over 3%. Although modest by historical standards, the projected pace of UK GDP growth is slightly faster than the diminished rate of supply growth, which averages around 1½% per year. A margin of excess demand is therefore expected to build, feeding through into higher growth in domestic costs. The contribution of external cost pressures, which has accounted for above-target inflation since the beginning of 2017, is projected to ease over the forecast period. Taking these influences together, CPI inflation is projected to remain above the target for most of the forecast period, before reaching 2% by the end of the third year.
The economic outlook will depend significantly on the nature of EU withdrawal, in particular the form of new trading arrangements, the smoothness of the transition to them and the responses of households, businesses and financial markets. The implications for the appropriate path of monetary policy will depend on the balance of the effects on demand, supply and the exchange rate. The MPC judges that the monetary policy response to Brexit, whatever form it takes, will not be automatic and could be in either direction.
At this meeting the MPC judged that the current stance of monetary policy remained appropriate. The Committee also judges that, were the economy to continue to develop broadly in line with the November Inflation Report projections, an ongoing tightening of monetary policy over the forecast period would be appropriate to return inflation sustainably to the 2% target at a conventional horizon. Any future increases in Bank Rate are likely to be at a gradual pace and to a limited extent. “