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 9 September 2015, 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 rose slightly to 0.1% in July but remains well below the 2% target rate. Around three quarters of the gap between inflation and the target reflects unusually low contributions from energy, food, and other imported goods prices. The remaining quarter reflects the past weakness of domestic cost growth, and unit labour costs in particular. Although pay growth has recovered somewhat since the turn of the year, the recent increase in productivity means that the annual rate of growth in unit wage costs is currently around 1% – lower than would be consistent with meeting the inflation target in the medium term, were it to persist. Additionally, sterling’s appreciation since mid-2013 is having a continuing impact on the prices of imported goods. A combination of these factors has meant that the average of a range of measures of core inflation remains subdued, although it picked up slightly in July to a little over 1%.
Inflation is below the target and the Committee’s best collective judgement is that there remain at least some underutilised resources in the economy. In that light, the Committee intends to set monetary policy in order to ensure that growth is sufficient to absorb the remaining economic slack so as to return inflation to the target within two years.
The Committee set out its most recent detailed assessment of the economic outlook in the August Inflation Report. The aim of returning inflation to the target within two years was thought likely to be achieved conditional upon Bank Rate following the gently rising path implied by the market yields prevailing at the time. Private domestic demand growth was forecast to be robust enough to eliminate the margin of spare capacity over the next year or so, despite the continuing fiscal consolidation and modest global growth. And that, in turn, was expected to result in the increase in domestic costs needed to return inflation to the target in the medium term, as the temporary negative impact on inflation of lower energy, food and import prices waned. In the third year of the projection, inflation was forecast to move slightly above the target as sustained growth led to a margin of excess demand.
The Committee noted in the August Report that the risks to the growth outlook were skewed moderately to the downside, in part reflecting risks to activity in the euro area and China. Developments since then have increased the risks to prospects in China, as well as to other emerging economies. This led to markedly higher volatility in commodity prices and global financial markets.
While these developments have the potential to add to the global headwinds to UK growth and inflation, they must be weighed against the prospects for a continued healthy domestic expansion. Domestic momentum is being underpinned by robust real income growth, supportive credit conditions, and elevated business and consumer confidence. The rate of unemployment has fallen by over 2 percentage points since the middle of 2013, although that decline has levelled off more recently. Global developments do not as yet appear sufficient to alter materially the central outlook described in the August Report, but the greater downside risks to the global environment merit close monitoring for any impact on domestic economic activity.
There remains a range of views among MPC members about the balance of risks to inflation relative to the target. At the Committee’s meeting ending on 9 September 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 would otherwise be likely to lead to inflation overshooting the target in the medium term.
All members agree that, given the likely persistence of the headwinds weighing on the economy, when Bank Rate does begin to rise, it is expected to do so more gradually and to a lower level than in recent cycles. This guidance is an expectation, not a promise. The actual path that Bank Rate will follow over the next few years will depend on the economic circumstances.
