Bank of England jacks up 2017 GDP forecast to 2%
Alongside its decision to leave monetary policy unchanged for another month, the Bank of England made a huge upgrade to its forecast for UK economic growth this year and continues to see above-target inflation for the coming three years.
The Bank's forecast for 2017 gross domestic product was lifted significantly to 2% from the 1.4% predicted in November and revised down its inflation forecasts for two years ahead.
On top of the fiscal stimulus announced in the Chancellor's Autumn Statement, the Bank's quarterly Inflation Report cited firmer momentum in global activity, higher global equity prices and more supportive UK credit conditions, with consumers also seen as likely to temporarily reduce saving rather than spending in the face of slowing in real income growth as inflation overtakes wage growth.
For 2018 and 2019, the economy is expected to grow by 1.6% and 1.7% respectively, up from the 1.5% and 1.6% seen in November.
The BoE's outlook for CPI inflation this year remains high at 2.7%, though nudged down from 2.8%, while in 2018 it is still expected to be 2.6%.
At present the monetary policy committee still felt it remained appropriate to let inflation run above target, saying "the continuing suitability of the current policy stance depends on the trade-off between above-target inflation and slack in the economy".
Principally they are for the current weakness in sterling continuing to boost consumer prices, that wage growth remains modest, and that the strong rate of household spending growth slows as real income gains weaken.
Governor Mark Carney said if spending growth slows more abruptly than expected, "there is scope for monetary policy to be loosened.
"If, on the other hand, pay growth picks up by more than anticipated, monetary policy may need to be tightened to a greater degree than the gently rising path implied by market yields."
He reiterated his previous comments that 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.
Market reaction - no UK rate hike seen in 2017
The pound fell in reaction and the yield on the 10-year benchmark gilt was down three basis points to 1.415%, with the two year yield down two basis points 0.12%.
Analyst Neil Wilson at ETX Capital said there appeared to be significant hurdles to the Bank hiking interest rates any time soon and highlighted comments around monetary policy not being enough to combat the real adjustment required for new trading arrangements.
"The bank noted that ‘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’. This looks like a major barrier to rates being hiked."
While he said the Bank had to gobble some humble pie as the economic armageddon in the event of Brexit has not materialised as promised, but he said Carney was correct to highlight the downside risks that yet remain, with Britain heading out of the EU with no guarantees on trade. "No one should doubt the importance of what this means, particularly regards the sterling exchange rate," Wilson said.
While the forecast for inflation was hiked over the next couple of quarters, more important to economist Sam Tombs at Pantheon Macroeconomics was that the MPC revised down its two-year ahead forecast, "the most relevant indicator for policy" to 2.6% from 2.7%.
"These revisions seem to reflect signs that the import price shock is filtering through to consumers faster than it thought previously."
With MPC minutes noting that “some” members felt that they had “moved closer to the limits” for looking through a period of above-target inflation, Tombs said the core view at the Bank seemed to remain "that domestically-generated inflation, especially wage growth, will remain too weak to justify raising rates over the next year, a view we share".
Barclays economists were also of the view that monetary policy will remain unchanged for the foreseeable future, with the trade-off between downside risks to growth and upside risks to inflation, "and we do not believe data at this stage provide sufficient clarity to resolve that dichotomy".
Barclays noted that households are the main focus, with the MPC viewing households as not overly stretched at the moment, with household debt to income at 134%, or 16pp lower than the 2008 peak.
"However, they did take the view that the evolution of GDP growth during 2017 would depend on how consumers responded to slowing growth in real income from rising inflation.
"In particular, according to the Bank’s agents, the average expectation for pay settlement was 2.2% in 2017, which if realised, would in essence mean a return to negative real wage growth, and thus possibly push down private consumption."