Business

BoE more optimistic on economic outlook

Bank of England governor Mark Carney
Bank of England governor Mark Carney Bank of England governor Mark Carney

IN line with market expectations, the February meeting of the Bank of England’s Monetary Policy Committee (MPC) concluded last week with no changes to policy. The decision to leave policy unchanged was unanimous and the Bank noted that the economy continued to perform better than it had anticipated.

It stated that “there had been few signs of a slowdown in consumer spending”. It also acknowledged the “new fiscal stimulus” announced by the Chancellor, the “firmer momentum in global activity”, “higher equity prices” and “supportive credit conditions”.

Therefore, on the back of these factors, the MPC upgraded its assessment of the outlook for growth in the UK economy. This is reflected in the revisions to the GDP forecasts contained in last week’s Inflation Report. The Bank now expects growth of 2 per cent this year compared to 1.4 per cent back in November. For 2018, it is forecasting growth of 1.6 per cent (from 1.5 per cent) and for 2019 it is pencilling in GDP growth of 1.7 per cent (from 1.6 per cent).

Overall, economic growth is now envisaged to be “around 1 percentage point stronger than in the November projections” over the three year forecast period. However, in the press conference, Governor Carney commented that the “Brexit journey is really just beginning” and could entail “twists and turns along the way”.

It could also be argued that the UK economy could be in something of a Brexit ‘sweet spot’ at present, benefiting from loose monetary policy and the weaker sterling before negative impacts such as rising inflation take hold.

The negotiating process to decide on the UK’s EU exit terms and any new trading arrangement could drag on for quite some time. The outcome of these talks, which should begin in the coming months, will ultimately determine the long-run implications of Brexit for the economy.

In terms of inflation, despite a stronger growth outlook, the MPC’s forecast were “roughly unchanged compared to the November projections”. The Banks rationale for this is that the “stronger path for demand” is likely to be “matched by higher supply capacity”, notably in the labour market.

As a result, the MPC continues to expect inflation to peak at around 2.8 per cent in 2018. In this context of an overshoot of its 2 per cent inflation target, the BoE referenced the “balance” that must be obtained in the “trade off” between “returning inflation to the target” and the support that “monetary policy provides” to the economy.

The BoE judges that it remains “appropriate to seek to return inflation to the target over a somewhat longer period than usual”. Notwithstanding this view, the Bank continues to state that there are “limits to the extent that above-target inflation could be tolerated”. The BoE outlined three key judgements in this assessment.

Firstly, that inflation expectations would not be “adversely” impacted by the boost to consumer prices from sterling weakness. Secondly, that pay growth would remain “modest” and thirdly, that “household spending would slow as real income gains weaken”.

Therefore, the MPC retains its guidance that “monetary policy can respond, in either direction, to changes to the economic outlook”

Futures contracts suggest that the market expects that the next move from the BoE will be a rate hike, sometime around mid-2018.

However, we think this is unlikely as the UK will be in the middle of difficult Brexit negotiations at this time, while we also expect the economy to slow in the run up to the exit from the EU. Market reaction to last week’s MPC meeting saw sterling weaken, with downward pressure on UK yields also.

This suggests that the market had been expecting a more hawkish tone from the BoE, in line with its expectation that rates would be hiked in 2018 and 2019. There appears to be no sign that the Bank is thinking along these lines, giving the market some food for thought.